01Model
Build the economic model
A floating exchange rate is determined by currency demand and supply arising from trade, investment, speculation and policy expectations.
For exchange rates and the domestic economy, state the relationship between exchange rate and the relevant agents, then identify the ceteris-paribus conditions. The model is a disciplined simplification, not a complete description of reality.
- Define the central variables precisely.
- Identify the agents making decisions.
- State what is held constant and why that matters.
02Evidence
Apply evidence and data
Sterling appreciates while a UK exporter imports components but sells most output overseas.
Application in exchange rates and the domestic economy means using scale, direction, timing and source to alter the argument. Explain how the evidence changes the mechanism instead of merely naming the context or copying a figure.
- Check units, dates and whether values are nominal or real.
- Separate correlation from a supported causal inference.
- Identify winners, losers and the appropriate counterfactual.
03Analyse
Develop the mechanism
Currency demand or supply changes → exchange rate changes → import and export prices change → quantities, costs, inflation and AD respond with elasticity and time lags.
Carry this exchange rates and the domestic economy chain far enough to answer the question: identify the agent's response, the resulting market or macroeconomic change and why the outcome matters.
- Explain each arrow in the chain.
- Use the diagram or calculation in the written analysis.
- Distinguish short-run adjustment from longer-run response.
04Evaluate
Evaluate assumptions and magnitude
The net firm and macro effect depends on import content, hedging, invoicing currency, PED values, capacity and competitor pricing.
Evaluation of exchange rates and the domestic economy should change confidence in the result. Test elasticity, time lags, scale, incentives, distribution and unintended effects rather than adding a generic “however”.
- Which assumption is most fragile?
- Would a different elasticity reverse or only weaken the result?
- What evidence could change the judgement?
05Judge
Reach an informed judgement
For exchange rates and the domestic economy, choose the argument with the greatest contextual importance and explain why it outweighs the alternative. State the conditions under which it holds rather than repeating the introduction.
The opportunity cost and distributional effect of exchange rate matter. Political preferences may affect objectives, but the exam judgement must rest on transparent assumptions and evidence rather than ideology.
- Answer the exact command and scope.
- Rank the decisive factors.
- State a condition, timeframe and possible reason to revise the conclusion.
From theory to a testable claim
A floating exchange rate is determined by currency demand and supply arising from trade, investment, speculation and policy expectations.
Applied taskSterling appreciates while a UK exporter imports components but sells most output overseas.
Causal chain
Currency demand or supply changes → exchange rate changes → import and export prices change → quantities, costs, inflation and AD respond with elasticity and time lags.
Applied taskRewrite the exchange rates and the domestic economy chain with one piece of numerical or contextual evidence at the link where it changes the expected magnitude.
Evaluation that does work
The net firm and macro effect depends on import content, hedging, invoicing currency, PED values, capacity and competitor pricing.
Applied taskExplain whether this consideration weakens, delays, redistributes or reverses the predicted exchange rates and the domestic economy outcome.