The exchange rate diagram is one of the highest-yield Paper 2 tools. Students usually lose marks for one of two reasons: shifting the wrong curve or failing to explain what happens to exports and imports after the new equilibrium.
How to draw it
- Draw demand and supply for the currency
- Label the original equilibrium exchange rate
- Shift the correct curve
- Mark the new equilibrium clearly
Animated draw order
Student memory line: Rates up -> currency demand up -> ER up
IB Economics exchange rate diagram: interest rates rise, currency demand shifts right, and the exchange rate appreciates.
Example
Higher interest rates
Higher domestic interest rates attract hot-money inflows, raising demand for the currency. Demand shifts right, the currency appreciates, imports become cheaper, and exports become less price competitive.
Most common mistakes
- No currency label on the axes
- Explaining a movement along a curve instead of a shift
- Forgetting the trade consequences after appreciation
Practise turning the diagram into a full 4-mark response with the 4-mark answer guide.
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