What does a terms of trade index above 100 mean?

Export prices are high relative to import prices, so the same exports buy more imports.

Why can a weaker Hong Kong dollar improve the trade balance?

Exports become cheaper abroad and imports dearer at home, and the quantity effect dominates when elasticities are large enough.

How does the real exchange rate differ from the nominal rate?

The real rate is adjusted for the two price levels and reflects true competitiveness.

The trade balance worsens at first after a depreciation and improves only once quantities adjust.

S6 Economics paper 2: exchange rate changes and elasticities

2026-11-10

Tutor Prep Guide · S6 Economics Exchange Rate

Ten items cover changes in the terms of trade, the real exchange rate, purchasing power parity, elasticities and the J-curve.

Direct answers　Items 01 to 03 cover the terms of trade and depreciation size, 04 to 06 the real rate, purchasing power parity and the Marshall-Lerner condition, 07 to 09 the multiplier, reserves and the J-curve, and 10 the belief that import prices stay put after a depreciation.

01　Paper details (check answers afterwards)

Item	Detail
Questions	10
Suggested time	25
Difficulty mix	Foundation 3 · Intermediate 3 · Challenge 3 · Error redo 1
Chapter	Chapter: S6 Economics Balance of Payments and Exchange Rate
Level	S6

02　Questions (10 items)

FoundationThe export price index rises from 100 to 105 while the import price index rises from 100 to 120. Find the percentage change in the terms of trade.
FoundationThe terms of trade index is 110 with the base year at 100, and the import price index is 130. Find the export price index.
FoundationThe Hong Kong dollar weakens from 7.80 to 7.95 per US dollar. Find the percentage depreciation.
IntermediateThe domestic price index is 120, the foreign price index is 110, and the nominal rate is 8.00 Hong Kong dollars per US dollar. Find the real exchange rate.
IntermediateThe same basket costs 2,400 Hong Kong dollars locally and 300 US dollars abroad, while the actual rate is 7.80. Find the purchasing power parity rate and say whether the local currency is strong or weak.
IntermediateExport demand elasticity is 1.2 and import demand elasticity is 0.9. Under the Marshall-Lerner condition, can a depreciation improve the trade balance?
ChallengeAutonomous exports rise by 20 billion dollars and the marginal propensity to consume is 0.75. Find the multiplier and the change in gross domestic product.
ChallengeThe current account deficit is 25 billion dollars and net inflow to the capital and financial account, excluding reserves, is 18 billion. Find the change in reserve assets.
ChallengeAfter a depreciation, exports rise from 70 to 72 billion dollars and imports rise from 80 to 83 billion. Find the change in the trade balance and name the pattern.
Error redoA common slip: a 500 dollar phone is worth 3,900 Hong Kong dollars at 7.80, so the price is assumed unchanged after the rate moves to 7.95. What is the correct figure?

03　Answers and one-line notes

#	Answer	One-line note
1	The terms of trade fall by 12.5 per cent (105 over 120, minus one).	Export prices rising less than import prices worsens the terms of trade.
2	The export price index is 143 (110 times 130, divided by 100).	The terms of trade divide the export price index by the import price index.
3	A depreciation of 1.89 per cent ((7.95 minus 7.80) over 7.95).	The size of a depreciation is measured against the new foreign currency price.
4	The real rate is 7.33 Hong Kong dollars per US dollar (8.00 times 110 over 120).	The real exchange rate adjusts the nominal rate for the two price levels.
5	The parity rate is 8.00, so the actual rate of 7.80 leaves the Hong Kong dollar undervalued by 2.5 per cent.	The ratio of the two prices for one basket gives the purchasing power parity rate.
6	The absolute values sum to 2.1, which exceeds one, so a depreciation improves the trade balance.	Above one the quantity effect outweighs the price effect.
7	The multiplier is 4 and gross domestic product rises by 80 billion dollars (20 times 4).	The multiplier equals one divided by the marginal propensity to save.
8	Reserve assets fall by 7 billion dollars (25 minus 18).	Inflow covers part of the deficit and reserves pay the remainder.
9	The deficit widens from 10 billion to 11 billion, a worsening of 1 billion, which is the short-run J-curve effect.	Quantities adjust slowly, so the price effect worsens the balance at first.
10	The correct price is 3,975 Hong Kong dollars, which is 75 dollars more (500 times 7.95).	A weaker Hong Kong dollar makes imports dearer in local currency.

04　What to do after marking

After marking, redo only the wrong items and write down which step went wrong (formula, unit, or misread number).
Repeat the same item two days later; move to the next paper only when both attempts are correct.
Parents only need the answer and note columns; there is no need to explain every item.

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