Production possibility curves — practice question

Use production possibility curves to compare the output changes in the RoI and Iceland shown in Fig. 1.

• Use Fig. 2 to compare Iceland’s general price level in 2007 and 2015. [1]
• Explain two ways in which the fall in the value of the krona between the end of 2007 and the end of 2008 might have caused the rise in the rate of inflation shown in Fig. 2. [6]

Explain the factors that determine whether the devaluation of a currency such as the Icelandic krona would turn a current account deficit into a surplus.

Consider whether the costs to an economy of managing its exchange rate are greater than the benefits of such a system.