AOS 3 Flashcards
Relationship between trade and living standards
Living standards are closely linked to our interaction with other economies through international trade, that is broken up into imports and exports.
Imports
Transactions where households, businesses, government etc purchase goods or services produced by another nation.
Exports
Australian made goods and services that are purchased by foreign households, businesses and governments.
International trade enables the living standards of both trading countries to improve.
Australia will benefit from purchasing imports by having greater access to a wider range of goods and services at low prices and high quality.
Non-material aspects of living standards are improved through the purchase of overseas holidays or entertainment such as film and television.
Selling exports to overseas buyers generates greater income and can improve our material living standards.
We have a competitive advantage in the production and export of natural resources such as iron ore and coal as we have an abundance of these resources.
International trade creates competition which Spurs on innovation, lower prices and improved quality - all leading to a higher standard of living.
International trade allows the possibility of selling to a larger market So businesses can benefit from economies of scale. This allows businesses to spread the fixed Costs across a larger sales base.
This decreases costs per unit and should keep prices low - improving living standards because we will be paying
lower prices and can purchase more goods and services with less money.
Balance of payments
All financial transactions with the rest of the world are recorded in the Balance of Payments.
It is an accounting summary of where money is received from other countries and where Australia spends money in the rest of the world.
When money is received (money from o/s to Australia) it is recorded as a credit and will be a positive entry in the
accounts.
When money is spent (money from Australia to o/s) it is recorded as a debit and will be a negative entry in the
accounts.
THE CURRENT ACCOUNT
The Current Account records all receipts of a Current nature. A deficit on the CurrentAccount means that debits
have exceeded credits (payments overseas have exceed receipts from overseas)
The Current Account consists of:
The Balance on Merchandise Trade (BOMT)
Net Services
Net Primary Incomes
Net Secondary Incomes
THE BALANCE ON MERCHANDISE TRADE
This is calculated from the merchandise (goods) export receipts (credits) minus the merchandise import payments (debits).
These can be the sale or purchase of manufactured goods.
NET SERVICES
Made up of the services export receipts (credits). minus sen/ice import payments (debits).
This can include receipts from education provided to foreigners (credits) or money Spent overseas by Australian tourists (debits).
BALANCE ON GOODS AND SERVICES (BOGS)
The Balance on Goods and Services (BOGS) is the total of the BOMT and Net Services. This is sometimes referred to as the Trade Balance.
NET PRIMARY INCOMES
Made up of receipts (credits) of income from foreign assets such as dividends from shareholdings in foreign countries or interest repayments from foreigners, minus any payments (debits) of income to service foreign liabilities such as profits sent to overseas owners and interest repayments on foreign debt.
Net primary income is the typically the largest component of the Current Account and the main reason for the
Current Account Deficits that we experience in Australia.
NET SECONDARY INCOMES
This is generally a one-way movement of money where nothing is expected in return. It can include pensions from foreign countries. gifts, and foreign aid.
It is typically the smallest component on the Current Account
CAD AS A PERCENTAGE OF GDP
The CAD as a percentage of GDP is a common statistic referred to when discussing movements in the Current
account.
THE CAPITAL ACCOUNT
This account covers capital transfers such as migrant’s transfers and debt forgiveness. It also includes the
acquisition/disposal of non-produced, non-financial assets (such as sales of embassy land or copyrights) between
residents and non-residents.
THE FINANCIAL ACCOUNT
This account shows how we finance the Current Account. Recent figures show a CA surplus of approx $12b for the
last quarter. This means that we collectively received more from exports and earnings from foreign assets than we spent on imports and servicing foreign debt.
This $ 12b surplus is typically balanced through the CAFA as a $ 12b credit, bringing balance to the Balance of
Payments.
CAUSES OF AUSTRALIA’S CAD (IN THE PAST)
Structural causes
Structural causes
Investment is required to maximise our growth potential.
However the savings required to fund this investment cannot be raised entirely in Australia (Savings-investment Gap)
Therefore foreign funds flow into Australia (borrowing recorded in the Capital and Financial Accounts).
This builds up our net foreign debt (NFD) which has large outflows in the CurrentAccount to pay for the interest on
this debt.
Structural causes
Australia’s relatively low international competitiveness is also to blame.
High costs and low efficiency puts pressure on the current account.
Our low international competitiveness means that at times, we import more than export. and when we have had a surplus in BOGS. it is largely due to our mineral exports.
CAUSES OF AUSTRALIA’S CAD (AT TIMES)
Cyclical causes
Cyclical causes
Cyclical causes of the CAD fluctuate based on the phase of the business cycle or economic activity.
During strong periods of AD, the CAD will increase because of more borrowing from overseas to fund investment which results in increased primary income outflows to cover the interest repayments on external borrowing.
There is also likely more spillover into import spending, more likely resulting in a deficit for the trade balance.
COMPOSITION AND CAUSE OF NET FOREIGN DEBT AND NET FOREIGN EQUITIES
Net Foreign Liabilities (NFLs) are made up of Net Foreign Debt (NFD) and Net Foreign Equities (NFE). This is our
net financial obligations to the rest of the world and helps to determine the sustainability of our CAD.
NFD is our total borrowing from O/S and subtracting our total lending O/S.
It is made up of both Private Sector Debt (households and businesses) which accounts for about 60% of NFD and Public Sector Debt (Government) which accounts for about 40% of NFD.
Terms of trade
TOT is a ratio of the average prices received for Australian exports relative to our average prices of imports.
An increase in TOT means that there is an increase in the average prices received for exports relative to the average prices paid for imports.
This means that a greater volume of imports can be purchased from the sale of a given number of exports.
An increase in the TOT is considered to be favourable in terms of the impact on national income and the balance of payments as it will boost incomes and improve BOGS.
Causes in changes in TOT
Forces of supply and demand. E.g an increase in global demand for Australian exports will increase export price and improve tot and decrease in demand will see prices fall decreasing tot. Changes to the level of supply of goods we exports is going to affect the prices of exports and therefore TOT.
Changes to demand and supply of goods and services imported by Australia will affect import prices and TOT.
The effect of movement in TOT:
Economic growth, full employment, inflation
Growth in TOT leads to a rise in export income thus increases net exports and AD
Increased AD increases demand for labour thus puts downwards pressure on Unemployment rate
Improved TOT reduced price of import lowers cost of production and downwards pressure on prices.
Exchange rate
Key terms
Exchange rate, Trade weighted index (TWI), appreciation of exchange rate, depreciation of exchange rate
Exchange rate- The value of theAustralian follar when
compared to another currency.
Appreciation of Exchange Rate- One Australian dollar
can now purchase MORE of a foreign currency
Depreciation of Exchange Rate- One Australian dollar can
now purchase LESS of a foreign currency.
Trade Weighted Index (TWI)- The value of the Australian dollar when compared to a basket of currencies of our major trading partners.
Valuing AUD
The exchange rate of the Australian Dollar (AUD) is usually measured in comparison to the US Dollar (USD) or the Trade Weighted Index (TWI).
The AUD/USD exchange rate usually sits
around $1 AUD : $0.70 USD.
The TWI is the average value of the AUD as
compared to a weighted basket of foreign
currencies.
THE BIG MAC INDEX
In Theory The value of a Big Mac should be the same in every country if we use exchange rates.
In Reality The value of a Big Mac varies in different countries
Relative Interest Rates
If Australian interest rates rise relative to
the interest rates in the USA, where are
foreign investors more likely to invest their
money?
Capital inflow: money moving into Australia
Capital outflow: money moving out of Australia
Terms of Trade and exchange rates
An increase in the TOT means prices received for exports have increased relative to the price paid for imports. What happens to the exchange rate as commodity prices rise?
RELATIVE RATES OF INFLATION
Inflation is a sustained increase in the
general level of prices which can negatively
effect international competitiveness.
If Australia has high inflation leading to a
reduction in net export demand, how does
this effect the exchange rate?
DEMAND AND SUPPLY
OF EXPORTS & IMPORTS
Overseas rates of growth
Economic growth in the rest of the world should
increase demand for Australian exports.
How does this effect the exchange rate?
Microeconomic demand/supply factors
Positive climate conditions should reduce the
production costs for agricultural exporters,
increasing export demand.
How does this effect the exchange rate?
CURRENCY AS AN
ECONOMIC STABILISER
Strong economic activity
During times of strong economic activity from increased
net exports, the AUD will appreciate.
Weak economic activity
During times of weak economic activity, net export growth is low
MACROECONOMIC GOALS
& LIVING STANDARDS
AUD Depreciates
The demand side effects on economic growth are
positive.
These positive effects are reduced by the negative
supply side impact as the lower value of the AUD will
make intermediate imports and capital imports more
expensive.
Impedes economic growth and material living
standards as measured by real GDP per capita.
AUD Depreciates
The demand side effects on economic growth are
positive.
These positive effects are reduced by the negative
supply side impact as the lower value of the AUD will
make intermediate imports and capital imports more
expensive.
stimulates economic growth and material living
standards as measured by real GDP per capita
CURRENT ACCOUNT
BALANCE
• Higher AUD Values
Lower net export demand, leading to a smaller
BOGS surplus, and a larger CAD.
• Lower AUD Values
Increases net export demand, leading to a larger BOGS surplus and a smaller CAD.
International competitiveness
Measures a country’s ability to compete in global markets based on price and non-price factors such as quality.
Improvements in international competitiveness can help improve the Current Account position.
Factors that influence Australia’s international competitiveness
Productivity Production costs Availability of natural resources Exchange rates Relative rates of inflation
The effect of trade liberalisation
Trade liberalisation refers to any government policy that is designed to promote free trade by way of reducing restrictions or barriers to trade with other countries.
Trade barriers come in the form of:
Quotas - a limit on the volume of imports
Tariffs -a tax on imports
Subsidies - financial assistance
The effect of trade liberalisation 1
Trade protections of output employment and incomes may benefit some groups in the short term, but in the long term it tends to result in negative outcomes.
This is because higher levels of protection reduce competition, resulting in less pressure to minimise costs and prices.
There is less incentive to improve efficiency and perfomance.
The effect of trade liberalisation 2
Exposing Australian businesses to greater levels of competition encourages increased productivity and growth in the economy.
Australian businesses exposed to competition are forced to focus on using resources in the best possible way, becoming more technically efficient.
Allocative efficiency is also more likely to be achieved because resources are going to be reallocated to more productive sectors in the economy.
The effect of trade liberalisation 3
Trade liberalisation is capable of assisting the long term attainment of each of the Government’s domestic economic goals - lower inflation, full employment and strong and sustainable growth.
It has the ability to improve living standards as we will have better access to a wide range goods and services to satisfy our needs and wants at lower prices and improved quality.
