Examination report for the Academic year 2018-19
January 2019 Examination period



International Economics
ECON30074

Unit Director: Luís P. Correia
Total number of candidates: 239 present
Summary of Results:
Fails

Third (40-50) Lower second
(50-60)
Upper second
(60-70)
First (70+)
0.8% 1.7% 17.6% 63.2% 16.7%

Overall Q1 Q2 Q3 Q4 Q5 Q6 Q7
% attempts 72% 52% 20% 65% 38% 24% 28%
Marks available 100 33.3 33.3 33.3 33.3 33.3 33.3 33.3
Max (in %) 77 78 79 78 76 78 78 78
Mean (in %) 63.3 63.7 61.9 60 64.2 63.8 64.9 64.9
Median (in %) 64.5 64.5 63 64.5 65.5 65.5 66 66
Min (in %) 14 31 33 13.5 30 48 48 45

Description of examination

3-hour closed book examination consisting of essay questions.

Rubric of examination

Answer THREE questions from the following SEVEN, at least ONE from Section 1 and at least ONE
from Section 2.
All questions carry equal marks.

General Feedback

Once again it was very pleasing to have 80% of the marks 2.1s and firsts. Perhaps because of the
possibility to specialise in two topics per Section (International Macro and International Trade)
during revision time, the typical answer shows a really solid understanding of the subject and
focuses on the question asked.

The best answers see all the main implications of the question, use theory to give substance to the
arguments, explain everything really well (diagrams, equations, non-obvious economics, etc.), use
precise language (e.g., candidates may write “the nominal exchange rate” rather than just “the
exchange rate”; or they may write “an unanticipated permanent shock” rather than just “a shock”),
illustrate the points made creatively with real-world examples and show evidence of reading
beyond the basic material. These are the positives…

Examination report for the Academic year 2018-19
January 2019 Examination period



However, there are a (small?) number of students that clearly specialise too much and then are
“forced” to answer a question that they do not feel comfortable with. This year that was clearly the
case with question #3 (the one divided into four parts) and question #6. In question #3, those
students lost many marks for not knowing at all (or only having a vague idea of) what a Currency
Board Arrangement, the European Single Supervisory Mechanism and the Single Resolution
Mechanism are. And in question #6 many of those students showed a poor understanding of the
Specific Factors model. It is deeply frustrating when a fair number of final-year students do not take
notice of the advice given regarding the structure of the exam and specialisation: the first (!) slide
of the revision material states “studying 2 topics from each Section should be relatively risk-free,
studying a 5th would give you even more choice”. And in those revision sessions, it is always
emphasised that when one studies a topic, it has to be the whole topic, not just 70 or 80% of it.

Too many candidates lose marks due to not focusing on the actual question. For instance, in
question #2 (on the East Asian financial crisis), too many students thought it would be good to opt
for breadth of coverage of the topic rather than answer the question: many answers focused on
different currency crises rather than on the EAFC.

Other times the basic mistake is just not reading the question carefully enough. For example, in
question #7, part (ii), several students decided to look at the impact of an export subsidy even
though the question asked them to study a (per-unit) production subsidy.

Once again and despite much advice, too many students still write equations or draw diagrams with
little explanation; or they “explain” the impact of shocks with sentences such as “variable x
increases, so curve y shifts to the right, so there is a new equilibrium with a higher z…”, and so on,
without ever focusing on the economics. For instance, stating that under a flexible exchange rate
regime there is an interest parity condition and then writing it down does not shown understanding
of economics. The understanding part comes from writing something such as “with floating
exchange rates and perfect capital mobility, the exchange rate will move to equalise the (risk-
adjusted) expected returns on equivalent assets when denominated in the same currency.”

There are still too many spelling mistakes of simple words. Apostrophes are added where there
should be none (e.g., “It’s volatility”, “it’s value”, “it’s exports”), and omitted when required (e.g.,
“Ricardos insight”); also quite a few “comparitive advantages”, several “tariffs” and “volitilities” lots
of “countrys”, a few “a countries income”, at least one “overhitting economy,”…

A small minority showed great confusion about basic economics. To give a few examples, it is not
true that when the economy is operating above full employment (ybar), the government (!) must
increase prices to bring the economy back to ybar; also, no, the balance of payments being equal
to zero has nothing to do with the balanced sheet of the government being balanced; no, an
increase in the supply of money does not shift the output market curve (that’s confusing a
movement along a curve with a shift of the curve); and finally, a fixed exchange rate that does not
impose a fiscal straightjacket.

Finally, there is no such thing as the Indonesian dollar; and David Ricardo (1772-1823) was not
involved in the writing of the 1977 paper by Dornbusch, Fischer and Samuelson on Ricardian trade
theory!


Examination report for the Academic year 2018-19
January 2019 Examination period





Specific Feedback on each question:
Question 1 (Section 1 – Open Economy Macro)
Theme of question: Floating exchange rates and exchange rate volatility
Number of candidates answering the question: 172 (74%)

This was the most popular question with the students but unfortunately it was the second one with
the lowest percentage of first-class marks: only about 13% of students got 70 or better in this
question.

The best answers showed that yes, exchange rate volatility could indeed reflect volatile monetary
and fiscal policies but there was also scope for many other influences, such as external shocks,
changes in consumer and investment confidence, changes in risk premia, the need to rebalance and
the existence of “carry trade”. Often the best answers would use AA-DD analysis and also showed
that the spot exchange rate can be seen as a forward-looking variable that responds to news about
domestic and foreign interest rates, the outlook for the economy, etc. Many good answers
illustrated some of the points with the pound sterling, the Turkish lira or the Argentine peso.

Many students interpreted the question very narrowly and proceeded to just discuss the classic
overshooting result emphasised by Dornbusch (1976). “Overshooting” of the exchange rate
following an unanticipated permanent money supply shock is indeed a really good case of volatility,
but volatility is far broader than this. An exchange rate is volatile when it goes up and down over
time, often very quickly and in an abrupt way.

Volatility in policy is associated with the idea of a shock: the shock may be “permanent” or
“temporary”, as long as it has not been anticipated by markets, it will typically have an impact on
the exchange rate.
Question 2 (Section 1 – Open Economy Macro)
Theme of question: East Asian financial crisis
Number of candidates answering the question: 125 (52%)

This was the third most popular question with the candidates but only about 12% of the answers
were deemed first-class.

The main problem with this question was a lack of focus on the actual question. Too many students
did one of the following. Either they spent most of their essay simply describing the EAFC (a good,
solid narrative of the crisis) or they wrote what read like a pre-prepared answer that went over the
various generations of models of currency crises that they had been taught. Several of those
“generic answers” tried to justify the approach taken with verbs such as “Suppose” or “Assume”,
apparently without realising that the question was about a real-world crisis. So, in a nutshell, there
was quite a lot of irrelevant stuff in many answers and this is perhaps the key reason why these
may have been awarded (relatively) low marks.

The statement in the title alluded to a series of measures that should reduce the likelihood of future
sudden stops and financial crises. The best answers explained the rationale behind the measures,
from reducing a dependence on external financing to adopting flexible exchange rates.
Examination report for the Academic year 2018-19
January 2019 Examination period



Many students failed to see that reducing dependence on external financing does not just reduce
the problems that arise with currency mismatches, it also makes countries far less vulnerable to
capital reversals. Many also missed the key point of the flexible exchange rate measure: not only
can the exchange rate now work as a real shocks absorber but it also means that the country’s
monetary policy can concentrate on domestic objectives.

The part that referred to “several vulnerabilities remain” was on average poorly answered even
though there was much about these (e.g., their financial systems remain bank-dominated and
heavily reliant on dollar-denominated debt instruments) in the key reading on the subject.

Two of the most common problems with the answers were as follows. First, in their account of the
1997 crisis, several candidates claimed that the peg to the dollar precluded the East Asian countries
from increasing their interest rates to incentivise capital inflows (or stem capital outflows) since
their rate (i) had to be equal to the US interest rate (i*). Only a perfectly credible fixed regime will
have i = i*. The interest rate set by the country that pegs its currency to another one has to be what
is required to convince investors not to take their money out of the country. This is what the
augmented interest parity condition shows.

Second, after reading that now East Asian economies all have adequate foreign exchange reserves,
many students felt compelled to explain a standard first-generation model (with a fixed exchange
rate) and then use it to argue that yes, it made sense for East Asian economies to now have
“adequate foreign exchange reserves.” But they claimed this without realising that these economies
now have flexible exchange rates. In other words, forex reserves need to be justified in another
way.

Finally, a small but common mistake when writing CA + KA + OFR = 0 was to describe OFR as Foreign
Exchange reserves rather than a change in the forex reserves account: what matters is the change.
Question 3 (Section 1 – Open Economy Macro)
Theme of question: different exchange rate regimes, the Euro and the euro crisis
Number of candidates answering this question: 47 (20%)

This was the least popular question with the students, but 19% of the answers were classified as
first-class and half of them achieved a mark of 64.5 or more.

In part (a) many students lost marks because they only did a money-demand shock. But one of the
advantages of a fixed exchange rate regime is the imposition of monetary discipline (no money
supply shocks). Some of the explanations were also quite unclear. For instance, a fixed exchange
rate is a choice and it requires constant intervention by the central bank.

As for part (b), many students did not really know what a currency board arrangement (CBA
henceforth) is or only had a vague idea about it. For instance, some just said that a CBA is a stricter
version of a fixed exchange rate, while others confused a CBA with “dollarization”.

As for part (c), a fair number of students simply missed the key point of the question and decided
to describe problems with the Euro project (e.g., lack of adherence to the Maastricht criteria, lack
of proper fiscal transfers, etc.). Still, the majority of students did get the main point of this part. But
they would often lose marks due to missing the link between a large capital and financial account
and a large current account; and/or they missed the point of the second statement and its link with
“internal devaluation:” for instance, some argued that it’s been difficult to regain competitiveness
since the Euro crisis due to the GIIPS’s failure to improve productive capacity. Finally, many answers
missed the link between higher inflation rates in the GIIPS and lower real borrowing rates.
Examination report for the Academic year 2018-19
January 2019 Examination period



As for part (d), several left it blank, which shows not only that they did not engage with the key
readings on the topic but also that they ignored the part of the lecture on the future of the Euro,
where we briefly covered the ECB has a LOLR (Lender of Last Resort) and BOLR (Buyer of Last
Resort), the pillars of a proper Banking Union and Fiscal Union. Many students confused the SRM
(Single Resolution Mechanism), a pillar of the banking union, with the ESM (European Stability
Mechanism), a lending toolkit, a component of the “fiscal union.”
Question 4 (Section 2 – International Trade)
Theme of question: Ricardian trade theory
Number of candidates answering this question: 155 (65%)

This was the second most popular question with the students and on average it was very well
answered: half of all answers achieved a mark of 65.5 or better and one in four were classified as
first-class.

The typical student had no problem with explaining the continuum of goods Ricardian trade model
well, using the right combination of simple analytical expressions, diagrams and verbal
explanations.

But several students failed to explain the part of the essay title that read “exports are good, imports
are bad” and/or missed the point of the part on “trade is balanced yet both countries gain relative
to a no-trade scenario”.

For the mercantilists, a country should try to export as much as possible and import as little as
possible. Now, in the national income accounts exports are indeed added to GDP whereas import
is subtracted from GDP. But Ricardo understood this was not the right way to think about the issue.
Specialisation benefits both countries but it requires moving resources to the sectors of the
economy with relatively high productivity, and this can only happen if each country is then allowed
to compensate for this by importing the products they are no longer producing. Moreover, overall,
the system must be in balance. This was Ricardo’s simplifying assumption in his parable of England,
Portugal, cloth and wine and it has been the simplifying assumption in trade theory ever since.
“Home” needs to import from “Foreign” roughly the same amount as it exports to “Foreign” in
order for trade between them to be sustainable. This is why it makes sense to impose the constraint
that total income equals total expenditure.

A fairly common mistake was to interpret balanced trade as meaning Home would produce half of
the continuum of goods. This is wrong: any point where the RD and RS curves intersect is, by
construction of the RS curve, a point where trade is balanced.
Question 5 (Section 2 – International Trade)
Theme of question: Specific Factors trade model
Number of candidates answering this question: 91 (38%)

This was the fourth most popular question with the students and about one in four answers were
deemed first-class.

Unfortunately, a very significant minority of the candidates simply ignored the essay title (this
started with “In the two-good Specific Factors model”) and proceeded to do one of the following:
they either answered the question just using Heckscher-Ohlin (HO) theory or they mixed HO with
the Specific Factors model. Now, to use the HO model was very problematic because one, the
question was about the Specific Factors model and two, it was very difficult to make much sense of
the essay title statements by relying only on HO predictions.

Examination report for the Academic year 2018-19
January 2019 Examination period



The question was very well-answered by many students that had a proper understanding of the
specific factors model. Nearly all of them were able to explain the first two statements clearly,
although the quality of the explanations of the key diagram, including the curves and the areas
representing the returns to factors varied quite substantially.

However, many of these students misunderstood the last statement. For instance, working in a
setting with specific factors capital and land, several students envisaged the owners of the land
sharing some of their returns with the labourers (!) rather than simply thinking about the possibility
that many farmers are also owners of the land they farm.

Another group of students had an incomplete understanding of the basic model. Mistakes (in
decreasing frequency order) included the following: (i) confusing nominal wages with real wages;
(ii) not understanding that nominal wages in the two sectors should be equal; (iii) confusing total
nominal returns to factors (say WL, with W the nominal wage per worker and L the number of
workers) and real returns per worker (W/P, with P the price level); (iv) stating that workers in the
exporting sector (say C) were after trade paid less than the value of their MPL since Pc had risen
more than the nominal wage W (i.e., they claimed that now W would also change so that W would still equal PcMPL.
Question 6 (Section 2 – International Trade)
Theme of question: Modern trade theory
Number of candidates answering this question: 57 (24%)

This was the 2nd least popular question with the students but it was also on average very well
answered: about one in five answers achieved a mark of 70 or better and roughly two-thirds
obtained a 2.1 mark.

The typical answer would explain quite well the gains from intra-industry trade, although there was
quite a lot of variability in the level of detail provided (e.g., when analysing the heterogeneous firms
case).

But only a minority of the students got the key reason for the difference in trade volumes between
the US and Canada and the US and Mexico: only the best answers stated that it had to do with most
trade in the US-Mexico case being inter-industry rather than intra-industry.

It was also disappointing, despite the emphasis on “the auto industry” and “wide range of
specialised firms” provided in the essay title that so few students thought of this intra-industry trade
(and the ever thinner slicing of the value chain) in terms of intermediate products/services. This
was the right approach (with the final output being “a car”), rather than thinking in terms of intra-
industry trade of finished cars.
Question 7 (Section 2 – International Trade)
Theme of question: Trade policy and the agricultural sector
Number of candidates answering this question: 68 (28%)

This was the third least popular of the questions with the students, but it was on average very well
answered (25% got first-class marks, and half of all answers achieved a mark of 66 or better).

The vast majority of students were able to answer part (i) very well. Still, hardly any student
bothered to explain why the various areas of their diagrams would correspond to changes in the
consumer surplus or producer surplus. The typical answer would just state that “domestic
producers gain area x” but not really explain it. Likewise, for the concepts of “consumption
distortion” and “production distortion”. Both are dead-weight-losses, but why? Regarding the
Examination report for the Academic year 2018-19
January 2019 Examination period



production distortion, some wrote because “(domestic) producers will produce more goods than
needed”! A minority only also explained the idea of terms-of-trade gain.

A few claimed that when an economy is small, the impact of a tariff would be negligible This is
wrong of course: what matters is the size of the deadweight losses and this depends on the size of
the tax and on the domestic elasticities of demand and supply.

Part (ii) was typically incomplete and had mistakes. Students had seen the right diagram for the
small open economy case. While nearly all remembered that a production subsidy would no longer
create a consumption distortion and also shifted the domestic supply to the right, very few were
able to shift it by the right amount and/or were able to identify the various areas correctly, including
the triangle that measures the production distortion. Hardly any student attempted the diagram
for the large open economy case.

Several students missed one of the key points of the question: production-subsidies are less
distortionary than a tariff that would result in the same reduction of imports.

There were several issues regarding the analysis of agriculture. A fair number of students discussed
material that was peripheral to the question, including infant industry arguments, and Mill and
Bastable tests. Some discussed the theoretical possibility of marginal social benefits that are not
captured by domestic producers. But they did not try to justify in what sense this could be plausible
in the agricultural sector.

It was also quite disappointing that so few students used the material from classes about protection
in agriculture. Several students ignored the part about “so many countries” and went on to argue
that it made sense to protect the sector due the existence of an optimum tariff. There was also
quite a lot about the USA (from the textbook?).

Two key reasons for protection (given that it is basically a CRS sector). One, the fact that it is very
“politically sensitive”: a big percentage of the population used to work in the sector; in most
countries the average incomes of farmers have been substantially below national incomes; and they
have access to powerful lobbies. Second, the argument of food security.


Issues identified with the examination
No issues were identified with the examination.
Signature of exam report author: Luís P. Correia
Date of Exam report: 13th of February 2019

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