Unit 3, Area of Study 3, Australia and the World

Question 1

Relationship between international trade and living standards = lower prices for consumers

Answer 1

As a general rule, increase in international trade has slowed inflation rates. A number of reasons for lower prices for consumers:

• Producers have access to cheapest suppliers. Increased competition for local producers.
• Reduced domestic market power.
• Increased wage competition. Economies of large scale production.

Link to living standards: Lower prices (inflation) means that real purchasing power of average incomes is usually higher = greater access to goods and services = higher living standards.

Question 2

Relationship between international trade and living standards = greater choice for consumers

Answer 2

1. For example, which car brands are imported and which ones are locally produced?
2. Name a locally produced mobile phone?
3. What goods or services that you consume are locally made?

Link: greater access to a wider range of goods and services improves material living standards, and general levels of satisfaction improve quality of life improving non material living standards.

Question 3

Relationship between international trade and living standards = ability to achieve economies of scale

Answer 3

Economies of scale: the volume that a firm needs to produce so that it is able to effectively cover its fixed costs and operate in a market at a competitive level.

To achieve economies of scale = to reach a production levels that results a decrease in average costs per unit of production ensuring a business is competitive.

Leads to lower overall costs of production = lower prices to the consumer.

Question 4

Relationship between international trade and living standards - Access to more resources for business and government.

Answer 4

• Australian businesses have access to physical capital (such as machinery) that may not be available in Australia, or cannot be acquired cheaply enough.
• Australian businesses have access to foreign human capital (i.e. workers) that may be in short supply in Australia which can assist in removing capacity constraints (such as skill shortages)
• Australian businesses have access to foreign financial capital (i.e. money) in the form of either debt or equity that helps them to expand their businesses via Investment.

International trade grows quantity and quality of resources available to local business allowing them to boost their production à growing businesses, jobs, incomes and profits, trade allows governments to access and pay for the various types of resources it needs to product public goods and infrastructure like transport, education, health and defence, thus improving living standards.

Question 5

Balance of Payments

Answer 5

A record of the financial transactions between economic agents of Australia and economic agents of the rest of the world.

Question 6

Credit to the Current Account or CAFA

Answer 6

Whenever money is received** (movement of money from foreign countries to Australia - **inflow). These are shown as positive in the accounts.

Question 7

Debit to the Current Account or CAFA

Answer 7

Whenever money is paid** (the movement of money from Australia to foreign countries - **outflow). These are shown as negative in the accounts.

Question 8

Current Account

Answer 8

Records all receipts and payments of a “current” nature. Consider current transactions as ones that do not create any future obligations

Consists of the following subaccounts:

1. Balance of Merchandise Trade
2. Net Services
3. Net Primary Income
4. Net Secondary Income

Question 9

Capital and Financial Account

Answer 9

Records all receipts and payments of a “capital” nature. Consider capital transactions as ones that create a future obligation or represent a net change in ownership of assets and liabilities.

Financial account consists of the following subaccounts:

1. Net direct investment
2. Net portfolio investment
3. Financial derivatives
4. Other investments
5. Net reserve assets

Question 10

Balance of Merchandise Trade

(Subaccount of the Current Account)

Answer 10

Value of export credits for goods or merchandise sold overseas (for example, wool, minerals, and manufactured items) minus value of import debits for goods purchased from abroad (for example, oil, electronic equipment and machinery).

Question 11

Net Services

(a subaccount of the Current Account)

Answer 11

Value of service credits received from overseas (for example, tourism, education, transportation and construction) minus value of service debits paid aboard (for example, for transportation, tourism and education).

Question 12

Balance of Goods and Services

Answer 12

BoMT + Net Services is referred to as Balance of Goods and Services (BoGS) and represents the ‘trade balance’ or (X - M)

(This is NOT a subaccount of the Current Account)

Question 13

Net Primary Income

(a subaccount of the Current Account)

Answer 13

The difference in value between income credits received from overseas (for example, wages, salaries, interest, dividends and profits) minus income debits paid out aboard (for example, wages, salaries, interest, rent, dividends and profit remittances).

Question 14

Net Secondary Income

(A subaccount of the current account)

Answer 14

Difference between the value of secondary income credits received by our residents (for example, non-life insurance transfers such as pensions) minus the value of secondary income debits paid aboard (such as gifts, taxes and some foreign aid donated by our residents).

Question 15

Net Direct Investment

(A subaccount in the Financial account / CAFA)

Answer 15

(Defined as 10% or above of ownership of shares) involves the purchase, setting up or expansion of companies and assets in Australia by foreigners classified as credits (the inflow of funds or assets) minus similar investments overseas by Australia residents classified as debits (the outflow of funds or liabilities).

Question 16

Net Other Investments

(A subaccount in the Financial account / CAFA)

Answer 16

includes credits (the inflow of funds or assets) minus debits (the outflow of funds or liabilities) for loans and deposits s(e.g. Deposits by ANZ in Swiss Bank accounts

Question 17

Net Reserve Assets

(A subaccount in the Financial account / CAFA)

Answer 17

contains both RBA and government transactions involving dealings in reserves of foreign currencies, gold, special drawing rights and required contributions to the International Monetary Fund (IMF). Money received from overseas are categorised as credits (the outflow of funds or liabilities) on Australia’s financial account.

Question 18

Structural factors that influence the Current Account Balance (Deficit / Surplus)

Answer 18

1. Savings / Investment imbalance - being such a young and small country, Australia does not have the level of savings required to fund the investment in our economy that is required to maximise our growth potential.
2. Low level of international competitiveness due to low levels of efficiency/productivity and high production costs (AGGREGATE SUPPLY FACTORS) = structural features of the economy that place structural pressures on the CAD.

Question 19

Cyclical factors that influence the Current Account Balance (Deficit / Surplus)

Answer 19

Cyclical component of the CAD: Movement in the CAD that is tied to changes in the economic cycle or levels of economic activity in the Australian economy (aggregate demand side of the economy).

• Strong domestic economic activity due to strong AD = gap between savings and investment grows (Household Savings Ratio could be evidence of this) & strong spending includes more imports as a result of AD factors such as improved consumer confidence, low interest rates, improved business confidence, a depreciating AUD.
  
  • Net Primary Income = more debits as we borrow more overseas
  • Trade balance moves further into deficit (more debits in the BoGS)
• Weak economic activity leads to the opposite.
• The cyclical movement of the CAD is likely due to swings in the BoGS which is largely due to swings in the business cycle.

Question 20

Net Foreign Debt

Answer 20

NFD is calculated by looking at the net debt obligations that flow from our ‘total borrowing’ from overseas and subtracting our ‘total lending’ to overseas.

Biggest part of NFL

Service in the form of repayments and interest payments.

Composition of NFD: Biggest contributor to NFD is the private sector (households and businesses) = approximately 80% of NFD

Public Sector (Government Debt) = < 20%

Question 21

Net Foreign Equity

Answer 21

NFE is equal to the net equity obligation that results from foreign ownership of Australia assets (e.g. property and shares), minus the Australian ownership of foreign assets.

Service in the form of profits or dividends

Question 22

Is Net Foreign Debt a problem?

Answer 22

• As previously acknowledge, debt is not always bad as long it is going toward sound investment projects that deliver ongoing returns and future benefits.
• However, when dollar depreciates, the debt burden (if denominated in a stronger currency such as the US dollar) gets worst – interest and loan repayments require more AUD to be converted into other currencies.
• If NFD rises too quickly and exceeds nations capacity to service, this can negatively impact our Credit Rating (currently Triple A), reflecting Australia to be a higher risk to lend to.

Question 23

Terms of Trade

Answer 23

Is a ratio of the average prices** received for Australian exports **relative** to the average **prices paid for our imports.

Question 24

Factors that influence Australia’s Terms of Trade

Answer 24

1. Global demand for Australian exports, determined by levels of economic activity in the eocnomies our Major Trading Partners.
2. Commodity prices (particularly iron ore and coal).

Remember: the best option is to use “Commodity Prices” as the factor, and reference Iron Ore and Coal as our number one and two exports. So their prices, directly impact Terms of Trade.

Question 25

Impact of a favourable movement in Terms of Trade on Current Account / balance of payments on current account.

Answer 25

↑ value of credits for exports and/or ↓ in value of debits for imports → ↑ (BoMT) = improving Current Account Balance (currently a Current Account Surplus)

Remember: Commodity prices are the key driving force behind our Terms of Trade.

Question 26

Impact of a unfavourable movement in Terms of Trade on Current Account / balance of payments on current account.

Answer 26

↓ value of credits for exports and/or ↑ in value of debits for imports → ↓ (BoMT) = worsening Current Account Balance (currently a Current Account Surplus)

Remember: Commodity prices are the key driving force behind our Terms of Trade.

Question 27

Impact of favourable movement in the Terms of Trade on goal of strong and sustainable economic growth

Answer 27

• A rise or favourable movement in the TOT driven by higher exports prices = higher national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = increase in private consumption expenditure and private investment expenditure = increase in AD = increase in levels of economic activity as producers increase production to meet demand = increase in real GDP (i.e. economic growth).*
• However, could create demand inflationary pressures in the economy impacting sustainability of growth.*

Question 28

Impact of unfavourable movement in the Terms of Trade on goal of strong and sustainable economic growth

Answer 28

• A fall or unfavourable movement in the TOT driven by lower exports prices = lower national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = decrease in private consumption expenditure and private investment expenditure = decrease in AD = decrease in levels of economic activity as producers decrease production to meet demand = decrease in real GDP (i.e. economic growth).*
• However, could reduce demand inflationary pressures in the economy impacting sustainability of growth.*

Question 29

Impact of favourable movement in the Terms of Trade on goal of full employment

Answer 29

A rise or favourable movement in the TOT driven by higher exports prices = higher national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = increase in private consumption expenditure and private investment expenditure = increase in AD = increase in levels of economic activity as producers increase production to meet demand = increase in real GDP (i.e. economic growth) = increase derived demand for labour in the economy = more jobs = lower unemployment.

Question 30

Impact of unfavourable movement in the Terms of Trade on goal of full employment

Answer 30

A fall or unfavourable movement in the TOT driven by lower exports prices = lower national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = decrease in private consumption expenditure and private investment expenditure = decrease in AD = decrease in levels of economic activity as producers decrease production to meet demand = decrease in real GDP (i.e. economic growth). = decrease derived demand for labour in the economy = less jobs = higher unemployment.

Question 31

Impact of favourable movement in the Terms of Trade on goal of low inflation

Answer 31

A rise or favourable movement in the TOT driven by higher exports prices = higher national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = increase in private consumption expenditure and private investment expenditure = increase in AD = increase in levels of economic activity as producers increase production to meet demand = moving the economy closer to it’s productive capacity and creating demand inflationary pressures in the economy, increasing price inflation.

Question 32

Impact of unfavourable movement in the Terms of Trade on goal of low inflation

Answer 32

A fall or unfavourable movement in the TOT driven by lower exports prices = lower national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = decrease in private consumption expenditure and private investment expenditure = decrease in AD = decrease in levels of economic activity as producers decrease production due to falling demand = the economy moving further away from it’s productive capacity and reducing demand inflationary pressures in the economy, decreasing price inflation.

Question 33

Impact of favourable movement in the Terms of Trade on living standards

Answer 33

A rise or favourable movement in the TOT driven by higher exports prices = higher national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = increase in private consumption expenditure and private investment expenditure = increase in AD = increase in levels of economic activity as producers increase production to meet demand = increase in real GDP (i.e. economic growth) = increase derived demand for labour in the economy = more jobs = lower unemployment. An increase in living standards as consumers have greater disposable income and access to goods and services, and their levels of financial stress are reduced, positively impacting on their physical and mental health.

Question 34

Impact of unfavourable movement in the Terms of Trade on living standards

Answer 34

A fall or unfavourable movement in the TOT driven by lower exports prices = lower national income or export income in the form of corporate profits and disposable incomes (particularly in the mining sector) = decrease in private consumption expenditure and private investment expenditure = decrease in AD = decrease in levels of economic activity as producers decrease production to meet demand = decrease in real GDP (i.e. economic growth). = decrease derived demand for labour in the economy = less jobs = higher unemployment. An decrease in living standards as consumers have lower disposable income and less access to goods and services, and their levels of financial stress increase, negatively impacting on their physical and mental health.

Question 35

Factors affecting the exchange rate / value of the AUD

Relative interest rates

Answer 35

Relative interest rates: the general level of interest rates in Australia compared to other countries (e.g. USA).

• If interest rates in Australia > Rest of the World.
• Increase in demand for AUD as foreign investors seek to invest in Australia
• If interest rates in Australia < Rest of the World.
• Increase in supply of AUD as Australian investors seek to invest in overseas

Question 36

Factors affecting the exchange rate / value of the AUD

Capital flows

Answer 36

• Capital inflow: movement of money into Australia = increase in demand for AUD = appreciation of the AUD
• Capital outflow: movement of money out of Australia = increase in supply for AUD = depreciation of the AUDs

Question 37

Factors affecting the exchange rate / value of the AUD

Demand for exports and imports

Answer 37

Demand for exports and imports – overseas rates of growth

• Levels of economic activity overseas in our major trading partners (e.g. China, Japan and Korea) = higher demand for Australian exports = increase demand for AUD in order to pay for Australian exports = appreciation of the AUD.

Demand for exports and imports – growth in national spending

• Strong levels of economic growth domestically = higher demand for imports = increase supply of the AUD as foreign currency is required to buy imports = depreciation of the AUD.

Question 38

Factors affecting the exchange rate / value of the AUD

The Terms of Trade

Answer 38

• Changes in the TOT is a major contributor to changes in the exchange rate.
• TOT rises:
  
  • means receiving higher prices for our exports relative to our imports → countries purchasing our commodities have required more AUD to buy them → increasing demand for the AUD and leading to an appreciating AUD
• TOT falls:
  
  • means receiving lower prices for our exports relative to our imports → countries purchasing our commodities have required less AUD to buy them → Decreasing demand for the AUD and leading to a depreciating AUD

Question 39

Factors affecting the exchange rate / value of the AUD

Relative rates of inflation

Answer 39

Problem: High rates of inflation negatively impact Australia’s international competitiveness.

Therefore if inflation rate is higher relative to the rest of the world, this will lead to:

• A depreciation of the AUD, due:
  
  • to a reduction in export demand resulting in lower demand for the AUD
  • An increase in import demand resulting in an increase in supply of the AUD.

Therefore if inflation rate is lower relative to the rest of the world, this will lead to:

• An appreciation of the AUD, due:
  
  • to a increase in export demand resulting in higher demand for the AUD
  • An decrease in import demand resulting in an decrease in supply of the AUD.

Question 40

What is the key link between a change in the value of the AUD (exchange rate) and the goals?

Answer 40

International competitivness and the impact this has on net exports (X-M) and AD.

Depreciation = increase int’l comp = X cheaper in FC terms and M more expensive in AUD terms = increase X and decrease M = increase in net exports (X-M)

Appreciation = decrease int’l comp = X more expensive in FC terms and M cheaper in AUD terms = decrease in X and increase in M = decrease in net exports (X-M)

Question 41

Impact of a depreciation on Current Account Balance

Answer 41

Increase in international competitiveness, therefore:

BoMT and Net Services = increase in value of credits and decrease in value of debits = improvement in CAB, currently a surplpus.

Net Primary Income:

• increase in value of debits, as more foreign investment in Australian companies leading to more dividends paid to foreign investors overseas.
• increase in value of debits for interest payments overseas for any debt held by Australian households or businesses that is in USD or another foreign currency.
• → detoriation of the CAB, currently a surplus.

Question 42

Impact of a appreciation on Current Account Balance

Answer 42

Decrease in international competitiveness, therefore:

BoMT and Net Services = decrease in value of credits and increase in value of debits = deteroriation in CAB, currently a surplus.

Net Primary Income:

• increase in value of credits, as more Australian’s invest in Foreign companies leading to more dividends paid to Australian investors from overseas.
• Decrease in value of debits for interest payments overseas for any debt held by Australian households or businesses that is in USD or another foreign currency.
• → improvement of the CAB, currently a surplus.

Question 43

Impact of a depreciation on goal of strong and sustainable economic growth

Answer 43

• Demand side: increase in International competitiveness → increase in X and decrease in M → increase in net exports (X-M) → increase AD → increase production as p’ers respond → increase economic activity / growth (real GDP) → 3 to 3.5%, strong enough to drive employment growth / but dem. infl. pressures = sustainable?
• Supply side: increase cost of production b’c imports more expensive in AUD terms = restraining any growth in productive capacity of economy.

Question 44

Impact of an appreciation on goal of strong and sustainable economic growth

Answer 44

• Demand side: decrease in International competitiveness → decrease in X and increase in M → decrease in net exports (X-M) → decrease AD → decrease production as p’ers respond → decrease economic activity / growth (real GDP) → 3 to 3.5%, strong enough to drive employment growth / but lower dem. infl. pressures so sustainable growth
• Supply side: decrease cost of production b’c imports less expensive in AUD terms = contributing to increase in productive capacity of economy.

Question 45

Impact of an appreciation on goal of strong and sustainable economic growth

Answer 45

• Demand side: decrease in International competitiveness → decrease in X and increase in M → decrease in net exports (X-M) → decrease AD → decrease production as p’ers respond → decrease economic activity / growth (real GDP) → 3 to 3.5%, strong enough to drive employment growth / but lower dem. infl. pressures so sustainable growth
• Supply side: decrease cost of production b’c imports less expensive in AUD terms = contributing to increase in productive capacity of economy.

Question 46

Impact of a depreciation on goal of full employment

Answer 46

= increase X and decreased M (X-M) = increase in AD = increase in economic activity as suppliers more willing to produce = increase in derived demand for labour = more jobs = reduction in unemployment.

Question 47

Impact of an appreciation on goal of full employment

Answer 47

= decrease X and increased M (X-M) = decrease in AD = decreased economic activity as supplies less willing to produce = decrease in DD4L = less jobs = increase unemployment.

Question 48

Impact of a depreciation on goal of low inflation

Answer 48

Demand side – a depreciating AUD, increases AD (via higher net exports) and this increases demand inflationary pressures

Supply side – a depreciating AUD, increases costs of production increasing cost inflationary pressures which feed through to higher consumers prices

Question 49

Impact of an appreciation on goal of low inflation

Answer 49

Demand side – an appreciating AUD, decreases AD (via lower net exports) and this decreases demand inflationary pressures).

Supply side – an appreciating AUD decreases costs of production, reducing cost inflationary pressures which feed through to lower consumer prices.

Question 50

Impact of changes in the value of the AUD on living standards.

Answer 50

Depreciation of AUD = cheaper AUD = increase in international competitiveness = increase in X – M = increase in AD = more jobs = higher disposable incomes = greater access to goods and services = improved material living standards.

More jobs = less financial stress = better physical and mental health = better quality of life = improved non-material living standards.

Appreciation of AUD = more expensive AUD = decrease in international competitiveness = decrease in X – M = decrease in AD = less jobs = lower disposable incomes = less access to goods and services = deterioration material living standards.

Fewer jobs = greater financial stress = worse physical and mental health = lower quality of life = reduced non-material living standards.

Question 51

Factors that influence Australia’s international competition

Answer 51

1. Productivity: is measured by the output per unit of input, an increase in producitivity = increase in outputs from given level of inputs = lower per unit cost = Australian producers are able to offer goods and services at lower prices = increase in international competitiveness.
2. Production costs: It improves producers’ ability to offer up goods and/or services at lower prices without reducing their profit margins, making Australian producers more competitive in international markets.
3. Availability of natural resources: e.g., mining and agriculture = increase in ability of Australia producers to provide goods and services overseas = increase to international competitiveness.
4. Exchange rates: depreciation = incresae in exports as now cheaper in foreign currency terms and decrease in imports, as domestic produced substitutes to imports now cheaper = increase in international competitiveness.
5. Relative rates of inflation: The price of Australian produced goods and services are likely to be lower than equivalent substitutes in competing economies, making Australian produced products more attractive to foreign and domestic consumers.

Question 52

Trade Liberalisation

Answer 52

Trade liberalisation includes any government policy initiative that is designed to promote free trade or reduce restrictions to free trade (typically referred to as barriers to trade or protection).

Question 53

Impact of Trade Liberalisation on international competitiveness

Answer 53

Trade liberalisation = ↑ competition = ↑ productivity and ↓ costs of production = ↑ productive capacity and aggregate supply = higher volume of production at lower prices = ↑ international competitiveness

Question 54

Impact of Trade Liberalisation on Current Account Balance (currently a surplus)

Answer 54

Trade liberalisation = ↑ competition = ↑ productivity and ↓ costs of production = ↑ productive capacity and aggregate supply = higher volume of production at lower prices = ↑ international competitiveness = ↑ value of credits to BoMT and Net Services = improvement in CAD/CAS

Question 55

Impact of Trade Liberalisation on goal of strong and sustainable economic growth

Answer 55

↑ competition = ↑ productivity and ↓ costs of production = ↑ productive capacity and aggregate supply = higher volume of production at lower prices = expansion increase in aggregate demand = ↑ in levels of economic activity (i.e. economic growth as measured by real GDP) and lower cost inflationary pressures (sustainability).

Question 56

Impact of Trade Liberalisation on Goal of inflation

Answer 56

↑ competition = ↑ productivity and ↓ costs of production = ↑ productive capacity and aggregate supply (willingness and ability to supply) = higher volume of production at lower prices ↓ cost inflationary pressures in the economy placing ↓ pressure on inflation / price stability.

Question 57

Impact of Trade Liberalisation on Goal of Full employment

Answer 57

Short term:

↑structural unemployment (restructure to improve efficiency may see businesses implement technology/make less-productive employees redundant) / some industries close down making all employees redundant.

Long term:

Improved AS → lower inflation → higher purchasing power → improved confidence → higher consumption & ↑ Int’l competitiveness ↑X & ↓M → ↑ AD → greater need for employees to meet demand → ↑DD4L → lower cyclical unemployment = full employment

Question 58

Causes of Net Foreign Debt

Answer 58

Basically, when we usually have a Current Account Deficit – this needs to be funded and we do this by borrowing from overseas (NFD) or seeking capital from foreign investors (NFE). Recent Current Account Surplus has seen a reversal in this trend.

• Lack of domestic savings (saving/investment imbalance or gap)
• Many budget deficits
• Stable economy to invest in politically, socially and economically