T2 Revision Notes for Success Flashcards
All factors that affect trade balance on current account
- World Business Cycle – Commodity Prices
- Domestic Business Cycle
- Relative Inflation Rates (International Competitiveness)
- Exchange Rates
- Terms of Trade changes
Factors impacting the income balance of the current account
- Investment-savings gap
- Interest Rates
- Company profits
Factors that influence - The Trade Balance Domestic Business cycle
When our economy expands at a rapid rate, the current account balance will decrease due to an increase in spending on imports. An increase in spending on imports will decrease the trade balance (exports minus imports) ceteris paribis.
On the other hand a slowing or contracting economy will see the trade balance and therefore the current account increase as spending on imports falls relative to exports.
Factors that influence - The Trade Balance World Business Cycle and Commodity prices
**The business cycle trends of the world, especially that of our main trading partners (ie China) has a big impact on Australia’s trade and therefore the current account.
If a trading partners economy rises (ie China), commodity export quantity and prices rise with the increase in demand. This boosts our export income (both price and quantity), increasing the trade and current account balance.
Factors that influence - The Trade BalanceAustralia’s international competitiveness –
Increasing wage levels relative to the rest of the world, as well as increasing relative inflation, decreases our international competitiveness for our exports. This reduces exports and therefore our trade and current account balance.
Factors that influence - The Trade Balance Exchange Rates
Movements in the exchange rates also affects the demand and supply for our exports as well as the demand for our imports.
A fall in the value of the Australian Dollar (a depreciation) will make Australia’s exports “cheaper” in foreign currency and lead to an increase in exports increasing the trade balance.
At the same time, it will also increase the price of imports for us, decreasing imports, which also increases the trade balance.
Historic income balance
the income balance has always been in a deficit.
This is because of Australia’s traditional reliance on foreign investment and therefore net capital inflow (where capital or investment inflow is greater than capital or investment outflow to other countries).
Factors that influence - The Income Balance
The Savings – Investment Gap
he Savings – Investment Gap
- Currently Australia has a mature resources sectors (especially in fields such as iron ore).
- The need for investment in Australia has lowered, and economic growth previously experienced has increased Australia’s savings.
- This has turned the Investment – Savings gap into a Savings – Investment gap.
- This has allowed Australia to increase its foreign investment abroad and therefore its income payments receivable, thus decreasing the income account balance.
Factors that influence - The Income Balance INTEREST RATES
Interest Rates
It is also important to understand that interest rates connected to foreign debt have an impact on interest payments (both to and from Australia). Higher interest rates means that interest payments receivable or payable will increase.
Factors that influence - The Income Balance,Company Profits
Additionally the level of company profits linked to foreign ownership has an impact on dividend payments/received. Australia’s recent increasing net income balance deficit, can be attributed to increased profits of Australian mining companies, which are partially foreign owned, meaning dividends are paid overseas.
What is capital account
- Comprises of non produced, non financial assets such as intangible assets such as patents, copyrights and trademarks.
include the transfer of migrant funds (permanent) to/from Australia.
Balance on this account is less than 1 billion
Saving investment gap in Australia
2019 to about 2024 saw Australia enter into a savings-investment gap.
This is reflected by the fact that the need for large scale investment into Australia had decreased. Our mining and energy infrastructure was mature and established.
Historically, Australia’s need for investment has been very high. Our savings have not been enough to finance these investments for many reasons, including our low population. We therefore have required to get foreign investment from abroad to close this gap
Net International Investment Position i
difference between the total foreign investment in Australia and Australian investment abroad.
Terms of trade defintion
- ## The terms of trade is an index which measures the relative movements in the price of exports and imports.
- XPI/ MPI times 100
Effects of increase in terms of trade
.Increase in the Trade Balance
2.Increase in Real GDP, Economic Growth, National Income and Living Standards
3.Decrease in the unemployment rate
4.Increase in government tax revenue
5.Increase in the inflation rate
6.Australian Dollar (AUD) appreciation
3 factors affecting TOT
XPI AND COMMODITY PRICES
MPI
change in exchange rate
TOT FACTOR XPI
Australia is what is known as a “price taker” in terms of export prices – The price of commodities is set by the demand and supply of the world market.
Australia’s exports are mainly primary commodities – mining and agricultural
As the demand and therefore the price of commodities increases, so too does the export price index
TOT FACTOR MPI
Australia’s imports are dominated by manufactured goods
Increases in the cost of production of these goods will increase the MPI and therefore reduce the ToT.
Oil prices spiked in 2022 due to the Ukraine-Russia war, which had knock on effects on petrol prices increasing the MPI.
Increased technology over time will reduce production costs especially for technology goods, which will reduce the MPI over time.
TOT FACTOR EXCHANGE RATE
A change in the exchange rate can also be the cause of a change in the terms of trade
For example:
A depreciation in the exchange rate will increase the price of imports in AUD terms. This will then increase our MPI.
At the same time, a depreciation of the AUD can impact on our export prices.
A depreciating exchange rate will mean that demand for our commodities increase as it is now cheaper in foreign currency, which would also increase the price of our exports and our XPI.
Therefore a depreciating AUD, will increase the XPI, but also increase the MPI.
The final result for our terms of trade will depend on the relative increase of the XPI vs the MPI.
If XPI increases more than MPI, the ToT improves. If MPI increases more than XPI, the ToT worsens.
TRENDS IN TOT LAST 10 YRS in Terms of trade
2016-2019:
World economic growth increases, saw an increase in demand for commodities and therefore saw our XPI increase.
XPI increased 40% in this time, and the ToT increased by 30% as there was a slight increase in MPI.
2020:
COVID-19 saw a global recession. XPI and MPI fell
2021:
Recovery of economies saw a surge in demand for commodities. This had a large effect on the XPI and TOT
2022:
War in Ukraine/Russia saw energy prices spike (LNG, coal, gas etc).
This increase in prices of our exports meant that ToT reached record highs
2022-2024:
After reaching high levels in 2022, iron ore prices declined, as China’s economic recovery was weaker than expected.
Countries focused on controlling inflation, rather than boosting infrastructure spending. This sharply reduced the XPI.
2022-2024:
As inflation gradually fell, so too did many production costs of imports.
This slightly lowered the MPI.
Trends in current account last 10 yrs
2016 - Defecit of 78 billion
2021 - Surplus of 63 billion
2024 - Defecit of 19 billion
Overall increase
2020 was first yr Aus recorded current account surplus in 40 years due to ( due to aus turning into saving invesmtent gap, large decrease in imports, decrease in net come defecit)
Aus recorded current account deficit 6 of last 10 years
Trends in net goods account and net services, net income balance
NET GOODS
2016 - defecit of 27.5 billion
2023 - net goods surplus of 151 billion
Net service account normally defecit due to high amount of import of travel+import but in 2020 went in surplus for first time but went back to defecit once restricitions were lifted
Net income balance is alwa7s in defecit due to high amount of historic net foreign investment in Aus
What is a two-speed economy, and how does it affect different sectors? Provide a definition and an example.
Definition: A two-speed economy occurs when different sectors or regions of an economy grow at different rates, typically due to varying levels of demand, investment, or resource dependence. One sector (or region) experiences rapid growth, while others lag behind, leading to economic imbalances.
Example: In Australia, the mining boom of the 2000s created a two-speed economy. Mining states like Western Australia and Queensland experienced rapid growth due to high demand for resources, while manufacturing and service-based states like Victoria and South Australia grew more slowly or even declined due to a high Australian dollar making exports less competitive.
What doe terms of trade reflect
It reflects the capacity of a **given quantity of exports to pay for a quantity of imports.*
.
