| Date | May 2017 | Marks available | 8 | Reference code | 17M.2.SL.TZ0.02 |
| Level | Standard level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Discuss | Question number | 02 | Adapted from | N/A |
Question
Australian economy feels the effects of falling iron ore price
- Iron ore is Australia’s largest export and the double effect of slowing growth in China and higher levels of production in Australia has driven the price of iron ore lower. In addition, the Australian dollar (AU$) has experienced a 10% depreciation against the US dollar (US$). These two factors combined have caused a dramatic worsening in the current account.
- Australian mining companies are losing significant revenue from falling commodity prices and this is further worsened by the rapidly depreciating currency. The Australian dollar traded at US$0.7375 on Wednesday, nearly at a six-year low.
- Australia recorded a monthly balance of trade deficit of AU$2.61 billion in May 2015, compared with a deficit of AU$1.61 billion a year earlier. The increasing deficit in Australia’s balance of trade is an indicator of potential declines in growth and employment, according to a foreign currency expert.
- The price of iron ore has fallen more than 67% between February 2013 and July 2015. In Australia, falling iron ore prices create downward pressure on economic growth. Australia’s real gross domestic product (GDP) grew 2% in 2015, down from 2.5% in 2014. Some economists noted that falling commodity prices reduced Australia’s export revenues by more than 2% of GDP in 2015.
- An expanding group of Australian-based economists argue that the central bank should further cut interest rates because of global economic uncertainty, falling commodity prices, weak consumer demand, and persistent weakness in non-mining sectors, such as tourism and education exports. Australia has been a popular destination for tourists and attracts many international students.
[Sources: Sydney Morning Herald: adapted from http://www.smh.com.au/business/markets/china-panic-feeds-into-australiansharemarket-20150708-gi7nyk.html
Marketwatch: adapted from www.marketwatch.com, accessed 26 July 2015. Reprinted with permission of MarketWatch, Copyright © 2015 Dow Jones & Company, Inc. All Rights Reserved Worldwide.]
Define the term depreciation indicated in bold in the text (paragraph 1).
Define the term current account indicated in bold in the text (paragraph 1).
Using an exchange rate diagram, explain why “slowing growth in China” may have caused a depreciation of the Australian dollar (paragraph 1).
Using a demand and supply diagram, explain why “the double effect of slowing growth in China and higher levels of production in Australia has driven the price of iron ore lower” (paragraph 1).
Using information from the text/data and your knowledge of economics, discuss the possible consequences for the Australian economy of the fall in the value of the Australian dollar.
Markscheme
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that the exchange rate falls.
2 Accurate definition. [2]
An explanation that it is a decrease in the value (price) of one currency (in terms of another currency) plus one of the following:
- in a floating exchange rate system
- as a result of market forces (supply and demand).
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that it is a measure of money, coming into and going out of a country, from international trade.
2 Accurate definition. [2]
An explanation that it is a measure of the net flows of funds from trade in goods and services, income and transfers (or the balances of trade in goods and services, net incomes, and net transfers).
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For drawing a correctly labelled exchange rate diagram, with a shift of the demand curve for the Australian dollar to the left or for an explanation that slowing growth in China will lead to a fall in demand for Australian exports thereby reducing demand for the Australian dollar, causing the Australian dollar to depreciate.
2 There is a correct diagram and an accurate written response. [3–4]
For drawing a correctly labelled exchange rate diagram, with a shift of the demand curve for the Australian dollar to the left and for an explanation that slowing growth in China will lead to a fall in demand for Australian exports thereby reducing demand for the Australian dollar, causing the Australian dollar to depreciate.
Candidates who incorrectly label diagrams can receive a maximum of [3].
For an exchange rate diagram, the vertical axis may be exchange rate, price of AUS$ in US$, US$/AUS$ or US$ per AUS$. The horizontal axis should be quantity, or quantity of Australian dollars. A title is not necessary.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For drawing a correctly labelled demand and supply diagram with a shift of the demand curve to the left and a shift of the supply curve to the right or for an explanation that slowing Chinese demand and increasing supply by iron ore producers will both have caused a fall in the price of iron ore.
2 There is a correct diagram and an accurate written response. [3–4]
For drawing a correctly labelled demand and supply diagram with a shift of the demand curve to the left and a shift of the supply curve to the right and for an explanation that slowing Chinese demand and increasing supply by iron ore producers will both have caused a fall in the price of iron ore.
If a candidate only shows and explains a single correct shift, then a maximum of [2] can be rewarded.
Candidates who incorrectly label diagrams can receive a maximum of [3].
The use of P and Q on the axes is sufficient for a demand and supply diagram. A title is not necessary.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Few relevant concepts are recognized.
There is basic knowledge/understanding. [1–2]
2 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is some attempt at application/analysis. [3–5]
3 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is effective application/analysis.
There is synthesis/evaluation, supported by appropriate theory and evidence. [6–8]
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Possible negative consequences include:
- “Australian mining companies are losing significant revenue” due to the fall in demand for exports (paragraph 2)
- “falling iron ore prices create downward pressure on economic growth” because mining profits fall, forcing mining companies to cut back on hiring and growth-oriented investment (paragraph 4)
- possibility of imported inflation through higher priced imports leading to higher input costs for manufacturers
- weak economy makes it difficult for central bank to raise interest rates to support the dollar (paragraph 5)
- falling value of currency can lead to low business confidence and uncertainty
- cutting interest rates will further depreciate the Australian dollar exacerbating a deterioration in the balance of trade and current account (paragraph 5)
- depreciating currency increases outflows on income line of current account as more dollars required to exchange for foreign currencies with which to pay income obligations – worsens current account deficit
- may lead to speculative outflows due to concerns that the Australian dollar is likely to depreciate further, leading to further downward pressure.
Possible positive consequences include:
- “persistent weakness in non-mining sectors” – depreciating currency likely to reduce relative price of service exports (tourism and education) thus improve balance of trade in services (paragraph 5)
- can encourage inflows on financial account as Australian assets are cheaper.
Possible mixed consequences include:
- Australian commodity exports should be more competitive but “slowing growth in China” likely to offset any gains from fall in relative price of commodity exports
- mixed impact on balance of trade – likely to improve services but less likely to improve goods because of dependency on commodity exports “Iron ore is Australia’s largest export” (paragraph 1).
Any reasonable discussion that offers a considered and balanced review of the possible effect of a depreciating currency on Australia’s economic growth.
