20/20 Exemplar Essay — Exchange Rates and Current Account

#Pearson Edexcel IAL Economics WEC12/01

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#THE QUESTION

"Evaluate the likely effects of a depreciation of the exchange rate on the macroeconomic performance of an economy of your choice." (20 marks — Evaluate: KAA 12 marks + Evaluation 8 marks)

Chosen economy: Egypt Context: Egyptian pound depreciated approximately 35% against the dollar in 2023; base rate rose to 27.25% by March 2024; persistent current account deficit driven by food and energy import dependence; CPI elevated pre-depreciation.

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#THE ESSAY — ANNOTATED

[P1 — KAA Chain 1: Depreciation → export competitiveness → CA improvement]

A depreciation of the domestic currency reduces the foreign currency price of domestic exports and raises the domestic currency price of imports — altering relative price competitiveness in a direction that, if the Marshall-Lerner condition is satisfied, improves the current account balance. [K ✓ — mechanism stated precisely; ML condition referenced]

Egypt's pound depreciating by approximately 35% against the dollar in 2023 — in a context of a structural current account deficit driven by food and energy import dependence — substantially reduced the dollar price of Egyptian manufactured goods, tourism services, and Suez Canal revenues for foreign buyers, while simultaneously raising the domestic cost of imported commodities. [App ✓ — 35% figure embedded mid-mechanism; CA deficit context established]

As Egyptian exports became price-competitive in international markets, export volumes in manufacturing and tourism rose while import demand contracted as domestically produced substitutes became relatively cheaper — provided that the combined price elasticity of demand for exports and imports exceeded unity (PED(X) + PED(M) > 1, the Marshall-Lerner condition). Net exports (X−M) therefore improved as a component of Egypt's current account, partially offsetting the structural deficit driven by inelastic food and energy import dependence. [An1 ✓ — mechanism developed; ML condition integrated; An2 ✓ — Stage 4: CA improves, structural deficit partially offset]

[P2 — Evaluation of Chain 1: J-curve and ML condition uncertainty]

However, this export competitiveness channel holds only if the Marshall-Lerner condition is satisfied in the long run — Egypt's high dependence on inelastic food and energy imports (price-inelastic necessities) means the short-run CA response follows the J-curve: the deficit initially worsens as import costs rise before volumes adjust. [Eval Type 1 ✓ — limits Chain 1; "only if" present; ML condition mechanism]

Egypt's import mix — dominated by wheat, petroleum products, and industrial inputs with limited short-run substitutes — suggests the price elasticity of imports is substantially below unity in the short run, meaning the J-curve trough may be deep and prolonged before any Marshall-Lerner recovery materialises. This holds only if export price elasticity is sufficient to compensate — Egypt's manufacturing and tourism export mix, while price-elastic in aggregate, requires 12–24 months for volume adjustment as contracts and tourist booking patterns adjust to the new price reality. [Eval anchor embedded — J-curve mechanism and time structure]

[P3 — KAA Chain 2: Depreciation → cost-push inflation → conflicting objective]

A second and directly conflicting effect of depreciation operates through the import cost channel: as the domestic currency price of imported raw materials, intermediate goods, consumer foods, and energy rises, production costs across the economy increase — shifting SRAS leftward as firms face higher input costs at every output level. [K ✓ — cost-push mechanism]

Egypt's 35% pound depreciation amplified pre-existing inflationary pressures that were already elevated — food and energy constitute a large share of Egyptian household expenditure, meaning import cost rises transmit rapidly and substantially to the CPI basket. With the depreciation occurring against a backdrop of elevated domestic inflation, the import price pass-through generated a significant second-order inflationary shock beyond the initial exchange rate movement. [App ✓ — 35% figure reused but in cost-push context; household expenditure structure embedded]

Rising import costs shifted SRAS leftward from SRAS₁ to SRAS₂ — generating cost-push inflationary pressure simultaneously with any export competitiveness improvement, creating the stagflation scenario where the price level rises while real output falls. Egypt's base rate therefore rising to 27.25% by March 2024 — the monetary policy response to the inflationary spiral — confirms that the depreciation's cost-push channel was sufficiently severe to require the most aggressive tightening cycle in Egypt's recent history, with the rate rise simultaneously compressing AD and risking a further deepening of the output gap. [An1 ✓ + An2 ✓ — stagflation mechanism; 27.25% rate embedded as Stage 4 confirmation; real output and price level both named]

[P4 — Evaluation of Chain 2: cost-push severity conditional on import mix]

However, the cost-push channel's severity depends critically on the economy's import dependency for essential goods — Egypt's particular vulnerability to food and energy import costs is not universal. [Eval Type 1 ✓ — limits Chain 2]

South Korea, by contrast, experienced the same global dollar appreciation context in 2022–2023 with a substantially different depreciation outcome — the won's depreciation raised export competitiveness (manufactured goods with high PED) without equivalent cost-push pressure, because South Korea's import mix is more diversified and its export mix is more price-elastic than Egypt's commodity-dependent structure. This holds only if the economy's import mix is dominated by inelastic necessities — a commodity-exporting economy with domestic food security would face a weaker cost-push channel from the same depreciation magnitude, making the stagflation risk Egypt-specific rather than universal. [Eval anchor — South Korea contrast; condition named]

[Conditional Judgement — all 5 elements]

On balance, the Egyptian pound's 35% depreciation generated net negative macroeconomic effects in the short run — the cost-push inflationary channel substantially outweighed the export competitiveness benefit given Egypt's structural import dependence on inelastic food and energy necessities. [Element 1: Decision — commits to one side using question's exact terms]

The decisive reason is the import mix: Egypt's CA deficit is driven by inelastic necessities rather than price-elastic manufactured imports, meaning the J-curve trough was deeper and the ML condition recovery slower than for economies with more diversified import structures — making the inflationary transmission faster and more severe than the competitiveness improvement. [Element 2: Justification — new reasoning not in body; import mix specificity]

Egypt's base rate reaching 27.25% — the central bank's response to the inflationary spiral triggered by the depreciation — confirms that the cost-push channel dominated: the monetary tightening required to contain inflation simultaneously deepened the output gap, confirming the net contractionary effect on macroeconomic performance in the short run. [Element 3: Extract anchor — 27.25% figure not used in this exact context in body]

This conclusion holds only if Egypt's import dependence on inelastic food and energy necessities remains structurally embedded — if Egypt successfully diversifies its import mix or develops domestic food and energy production capacity, future depreciations would face a weaker cost-push channel and a stronger ML competitiveness recovery. [Element 4: "Only if" condition — specific and tied to structural characteristic]

However, if an economy's export mix is highly price-elastic (South Korea's manufactured goods, tourism-dependent economies) and import dependence on inelastic necessities is limited, the same depreciation magnitude would generate a net positive macroeconomic effect as the competitiveness channel dominates — confirming that the welfare assessment of depreciation is entirely country-context-dependent rather than universally positive or negative. [Element 5: Counter-condition + new addition — South Korea as the counter-case; mechanism explained]

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#FULL AO AUDIT

KAA: Level 4 (11–12/12) — both chains at Stage 4 simultaneously, bilateral development, Egypt data embedded in both Eval: Level 3 top (7–8/8) — P2 and P4 both with mechanism and condition, judgement all 5 elements Total: 18–20/20

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#WHAT MAKES THIS 20/20 AND NOT 14/20

The 14/20 answer on this question has:

• Chain 1: depreciation → exports cheaper → CA improves ✓
• Chain 2: depreciation → imports expensive → inflation rises ✓
• BUT: "the Marshall-Lerner condition" mentioned but not explained — zero AO3
• BUT: J-curve not mentioned — short-run worsening missed entirely
• BUT: "However, this may cause inflation" — evaluation on Chain 1, but no mechanism and no condition
• BUT: "Overall, depreciation has mixed effects" — non-decision, no "only if", Level 2 eval cap

Four specific changes from 14/20 to 18/20:

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#WHAT MAKES THIS 20/20 AND NOT 17/20

The 17/20 answer has the above fixes but still misses:

1. South Korea as a contrast case in P4 — at 17/20, P4 evaluates Chain 2 but generically ("this depends on the economy's import mix"). At 20/20, South Korea provides the concrete counter-example with mechanism.
2. 27.25% rate in judgement as new data — at 17/20, the judgement uses the 35% depreciation figure again (already in body). At 20/20, the judgement introduces the 27.25% base rate as confirmation that cost-push dominated — a new data point not used in that context previously.
3. Structural condition in "only if" — at 17/20, "only if the ML condition holds" is present. At 20/20, the condition is more specific: "only if Egypt's import dependence on inelastic food and energy necessities remains structurally embedded" — tying the condition to Egypt's structural characteristics rather than a generic economic relationship.

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#C vs A vs A* — THE THREE DECISIVE DIFFERENCES

C answer (12/20): ML condition absent, J-curve absent, evaluation generic, unconditional conclusion Both chains present at Stage 3. "Depreciation improves the current account" — unconditional. "However, inflation rises" — no condition. "Overall, depreciation has mixed effects on macroeconomic performance" — non-decision, no "only if."

A answer (16–17/20): Both chains at Stage 4, ML condition stated, evaluation conditional ML condition named. Both chains to Stage 4. P2 present with "only if." But: P2 placed after both chains (not bilateral). Judgement has "only if" but no counter-condition. No South Korea contrast.

answer (18–20/20): Bilateral development, all 5 judgement elements, contrast economy* P2 immediately after Chain 1. South Korea as contrast in P4. Judgement: decision + justification + new data + "only if" specific condition + counter-condition with mechanism. Everything in the body confirmed by data.

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VERIDIAN™ | © VERIDIAN 2026. All rights reserved. This material is the intellectual property of VERIDIAN. Unauthorised reproduction, resale, or distribution is prohibited. For personal study use only. Not affiliated with or endorsed by Pearson Edexcel.