Explain how an appreciation of the krone could help Norway reduce inflation

AQA A-Level Economics Paper 2 June 2025

Extract B (lines 6–7) states: ‘Some analysts hope that, before long, the currency will start to appreciate which could help Norway reduce inflation.’

With the help of a suitable diagram, explain how an appreciation of the krone could help Norway reduce inflation. (9 marks)

1. Exchange rates are the price of a currency in terms of another.
2. Inflation is the rate at which the average price level is increasing.

1. A currency appreciation means that the currency has increased in value as a result of market forces (supply and demand).
2. As the Krone becomes more expensive, imports become cheaper and exports become more expensive for Norway.
3. This means that exports are likely to decrease and imports are likely to increase.
4. This leads to a decrease in aggregate demand.
5. Also a stronger Krone means that it is cheaper for firms in Norway to import raw materials.
6. As costs of production might fall, this might lead to an increase in short-run aggregate supply.
7. As aggregate demand falls and short-run aggregate supply increases, the price level falls from P1 to P2 as shown in the diagram below.

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