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Economics ATAR > Terms of trade > Flashcards

Terms of trade Flashcards

1
Q

What are the terms of trade?

A

An index which measures the relative movements in the prices of exports and imports

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2
Q

What does the terms of trade influence?

A

Balance of payments
The exchange rate
National income

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3
Q

Why is the terms of trade so important?

what does it provide a measure of

A
  • It provides a measure of the quantity of imports a country can obtain in exchange for a given volume of exports
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4
Q

What does it mean when the terms of trade increases?

A
  • To purchase a given quantity of imports it will require a smaller quantity of exports
  • A rise in the terms of trade would be synonymous with an increase in a county’s standard of living since more goods and services can be imported from a given amount of exports
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5
Q

Equation for the ToT

A

terms of trade= (export price index)/(import price index) ×100

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6
Q

What is a favourable movement in the terms of trade?

A
  • Occurs when export prices increase more than import prices

- Terms of trade increases

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7
Q

What is an unfavourable movement in the terms of trade?

A
  • Import prices increase more than export prices

- Terms of trade decreases

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8
Q

How can export and import prices both fall, but the terms of trade still increase?

A
  • Import prices fall by a greater proportion than export prices
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9
Q

Why are there large fluctuations in the prices of commodities?

A
  • Due to the inelastic demand and supply

- Small shifts in demand and supply can cause large fluctuations

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10
Q

Australia’s terms of trade are affected by what changes in the global economy?

A
  • Increases world economic growth
  • Increases the demand for our commodities such as minerals and energy
  • Increases their prices on the world market
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11
Q

Why does Australia have little influence on export and import prices?

A
  • Prices are largely set in the world market

- Australia is a price taker when it comes to traded goods

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12
Q

Describe the ToT over the past two centuries

A

1991-2001 → Stable terms of trade (around 50)
2001-2011 → Index doubled due to the mining boom (went from 52 to around 107)
2008-2009 → There was a decline in the ToT due to the GFC
2010-2012 → The index recovered
Since 2012 → World commodity prices have been falling, decreasing the terms of trade

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13
Q

Effect of the resources boom on the ToT?

A
  • Caused an increase in the ToT
  • There was strong demand for our commodities
  • This was associated with a massive increase in resource investment and a large appreciation of the exchange rate
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14
Q

What was the effect of emerging market economies on the ToT?

A
  • China and India
  • Resulted in an increase in demand for our commodities
  • GDP growth per capita: 5.5% in India, 10% in China
  • There was a huge demand for iron ore, coal and natural gas
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15
Q

What did the terms of trade have a prominent effect on?

A
  • The trade and current account balance in the balance of payments
  • The exchange rate
  • National income
  • Investment
  • Inflation
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16
Q

What is the link between the terms of trade and the trade account in the balance of payments

A
  • The terms of trade measures changes in the prices of exports and imports
  • The trade account measures the changes in the value of exports and imports
  • The trade account takes into account the prices of trades goods, as well as their quantities
17
Q

What is the relationship between the terms of trade and the balance of goods and services?
(examples eg. mining boom)

A
  • Direct relationship
  • A rise in the terms of trade would cause an increase in the trade balance and an increase in the current account balance
    EG. During the mining boom (2001-2012)
  • Australia’s export index increased (due to the increased demand for our commodities)
  • There were higher prices and higher sales for resource exports
  • The balance on goods and services increased
18
Q

How can a rise in the terms of trade cause a decrease on the trade account?

A
  • A rise in the terms of trade increases national income
  • Increases consumption
  • Spending on consumer imports will increase which may offset the increase in export income
19
Q

Effects of changes in the terms of trade on investment

A

The increased terms of trade during the mining boom resulted in an increase in investment into the mining and resource sector

The doubling of coal and iron ore prices (2011-12) attracted vast sums of capital into new mining projects to help boost supply capacity

20
Q

Effects of changes in the terms of trade on national income

A

A rise in the terms of trade will increase a country’s purchasing power, thereby increasing their real national income

↑ income = ↑ domestic economic activity and employment

Therefore, ↑ ToT leads to a boost in economic growth and living standards

21
Q

What is the difference between real gross income and GDP?

A

GDP provides an accurate measure of the volume of goods and services produced in an economy
- although it does not provide an accurate measure of the real purchasing power of the income generated by domestic production

Real gross income → GDP adjusted for the terms of trade and is a better measure of a country’s real purchasing power

22
Q

Effects of changes in the terms of trade on the exchange rates

A
  • Strong terms of trade will lead to an appreciation of the exchange rate
  • High export prices increases the demand for the Australian dollar, boosting its value
  • Between 2001-11 the value of the $A increased from $US0.50 to $US1.10
  • This reduced the price for imported goods and services
23
Q

What is the dutch decrease?

A
  • A high exchange rate is a disadvantage for domestic producers and exporters not in the mining sector
  • It reduces the competitiveness of their industries
  • Results in a ‘two speed’ economy
  • The mining sector boomed at a fast pace
  • Other domestic industries were adversely affected by the high exchange rate and grew at a much slower pace
24
Q

How does a rise in the terms of trade effect the inflation rate?

A
  • By increasing national income and spending, will have an expansionary effect on the economy and may be inflationary if the economy becomes close to full employment
  • may cause the reserve bank to raise interest rates
25
Q

How does a fall in the terms of trade effect the inflation rate?

A
  • Cause a contraction in the economy
  • Decreases net exports, investment and consumption spending
  • 2011-14 ToT fell by 25%
  • This marked the end of the mining boom
  • Fall in economic growth and rising unemployment

Economics ATAR (12 decks)

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