ECS3703
EXAM PACK
,ECS3703 - May June 2026
EXAM ANSWERS
QUESTION 1 [20 MARKS]
Indicate whether each statement is True (T) or False (F), and briefly justify your
answer.
1. The two parts of each transaction cannot be recorded in the current or financial
accounts.
False (F).
Each international transaction is recorded twice in the balance of payments under the
double-entry accounting system. The two entries may involve the current account
and financial account, or different items within these accounts.
2. Risk diversification is the main function of foreign exchange markets.
False (F).
The main functions of the foreign exchange market are to transfer purchasing power
between countries, provide credit for international transactions, and facilitate the
management of foreign-exchange risk. Risk diversification is not its main function.
3. A change from R1 = €1 to R2 = €1 represents appreciation.
False (F).
If the exchange rate is expressed as rand per euro, an increase from R1 to R2 per
euro means that the euro has become more expensive in rand terms. Therefore, the
rand has depreciated, while the euro has appreciated.
,4. An effective exchange rate is also known as a flexible exchange rate.
False (F).
An effective exchange rate is an index measuring a currency's value against a
weighted average of the currencies of major trading partners. A flexible exchange rate
refers to an exchange-rate regime in which the value of a currency is mainly determined
by market forces.
5. To correct a balance of payments deficit and address unemployment, a nation
requires a devaluation and fiscal policy.
True (T).
A devaluation can switch expenditure from foreign goods towards domestic goods,
improving the current account. Expansionary fiscal policy can increase aggregate
demand and employment. Thus, the two policies can be combined to address external
and internal imbalances. Devaluation is a principal expenditure-switching policy.
6. Direct controls form part of expenditure-switching policies but are applied
differently from exchange rates.
True (T).
Direct controls, such as trade controls and exchange controls, are expenditure-
switching measures because they restrict expenditure on foreign goods, services or
assets or encourage foreign-exchange inflows. They operate through restrictions rather
than through changes in the exchange rate.
, 7. Expenditure-changing policies can only be implemented through changes
related to government spending and taxes.
False (F).
Expenditure-changing policies include both fiscal and monetary policy. Fiscal policy
changes government spending and taxation, while monetary policy influences
aggregate expenditure through interest rates and the money supply.
8. The relative PPP theory gives better results in the short run than in the long
run.
False (F).
Purchasing Power Parity generally provides a better explanation of exchange rates in
the long run. In the short run, exchange rates are influenced by factors such as interest
rates, capital flows and speculation.
9. The absolute purchasing power parity includes both the current and financial
accounts of the balance of payments.
False (F).
Absolute PPP relates the exchange rate to the relative price levels of two countries:
R=PP∗R=\frac{P}{P^*}
It does not mean that the current and financial accounts are included in the PPP
relationship.
10. Imports are recorded on the credit side of the balance of payments under the
financial account.
EXAM PACK
,ECS3703 - May June 2026
EXAM ANSWERS
QUESTION 1 [20 MARKS]
Indicate whether each statement is True (T) or False (F), and briefly justify your
answer.
1. The two parts of each transaction cannot be recorded in the current or financial
accounts.
False (F).
Each international transaction is recorded twice in the balance of payments under the
double-entry accounting system. The two entries may involve the current account
and financial account, or different items within these accounts.
2. Risk diversification is the main function of foreign exchange markets.
False (F).
The main functions of the foreign exchange market are to transfer purchasing power
between countries, provide credit for international transactions, and facilitate the
management of foreign-exchange risk. Risk diversification is not its main function.
3. A change from R1 = €1 to R2 = €1 represents appreciation.
False (F).
If the exchange rate is expressed as rand per euro, an increase from R1 to R2 per
euro means that the euro has become more expensive in rand terms. Therefore, the
rand has depreciated, while the euro has appreciated.
,4. An effective exchange rate is also known as a flexible exchange rate.
False (F).
An effective exchange rate is an index measuring a currency's value against a
weighted average of the currencies of major trading partners. A flexible exchange rate
refers to an exchange-rate regime in which the value of a currency is mainly determined
by market forces.
5. To correct a balance of payments deficit and address unemployment, a nation
requires a devaluation and fiscal policy.
True (T).
A devaluation can switch expenditure from foreign goods towards domestic goods,
improving the current account. Expansionary fiscal policy can increase aggregate
demand and employment. Thus, the two policies can be combined to address external
and internal imbalances. Devaluation is a principal expenditure-switching policy.
6. Direct controls form part of expenditure-switching policies but are applied
differently from exchange rates.
True (T).
Direct controls, such as trade controls and exchange controls, are expenditure-
switching measures because they restrict expenditure on foreign goods, services or
assets or encourage foreign-exchange inflows. They operate through restrictions rather
than through changes in the exchange rate.
, 7. Expenditure-changing policies can only be implemented through changes
related to government spending and taxes.
False (F).
Expenditure-changing policies include both fiscal and monetary policy. Fiscal policy
changes government spending and taxation, while monetary policy influences
aggregate expenditure through interest rates and the money supply.
8. The relative PPP theory gives better results in the short run than in the long
run.
False (F).
Purchasing Power Parity generally provides a better explanation of exchange rates in
the long run. In the short run, exchange rates are influenced by factors such as interest
rates, capital flows and speculation.
9. The absolute purchasing power parity includes both the current and financial
accounts of the balance of payments.
False (F).
Absolute PPP relates the exchange rate to the relative price levels of two countries:
R=PP∗R=\frac{P}{P^*}
It does not mean that the current and financial accounts are included in the PPP
relationship.
10. Imports are recorded on the credit side of the balance of payments under the
financial account.
