Economics UNIT 3 AOS 3
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41 Terms
Trade liberalisation
The removal or reduction of trade barriers (such as tariffs, quotes and subsidies) between countries, allowing for free flow of goods, services and investments across borders, aiming to promote international trade by creating a more open, competitive and efficient global market
Absolute advantage
Country’s ability to produce a good or service more efficiently than other countries
Comparative cost advantage
Country’s ability to produce a good or service at a lower opportunity cost than another country, even if it does not have an absolute advantage in producing that good
Growth of international trade
Better access to resources:
Different nations have very different endowments of land, labour and capital resources. International trade allows for access to all of these factors of production, which has positive effects on the costs of production.
Increased international specialisation in production based on comparative cost advantage:
Domestic businesses are forced to compete with businesses from around the world, while businesses also tend to specialise in the areas of production in which they have the greatest advantage.
Greater economies of large-scale production:
Reduction in the average per unit production cost which occurs as businesses increase their levels of production, spreading large fixed capital and other costs across larger production runs.
Lower prices
More consumer choice
Higher GDP and average incomes
Balance of Payments (BOP)
A statistical or accounting record of the value of financial transactions between Australia and the rest of the world
Current Account
Goods: The difference in value between credits received for exports of goods sold overseas (including materials, merchandise goods), and the value of debits paid for imports of goods purchased from overseas (including capital goods and equipment, textiles and other merchandise goods) |
Services: The difference in value between credits received for exports of services sold (including foreign tourists spending money in Australia on hospitality) and the value of debits paid for imports of services (including the value of Australian tourism spending abroad, and financial and other services purchased abroad) |
Primary Income: The difference in value of income credits received (including wages, salaries, interest, dividends and profits), and the value of income debits paid abroad (including wages, salaries, interest, dividends and profits) |
Secondary Income: The difference in value between secondary income credits received by Australian residents and where nothing is expected in return (including gifts and pensions), and the value of secondary income debits paid abroad (including for gifts, pensions, some foreign food aid and taxes) |
Capital Account
Capital Transfers: Net inflow of funds into Australia by permanent migrants |
Net acquisition/disposal of non-produced, non-financial assets: The difference between credits and debits for the sale of copyright, patents, overseas franchises (such as KFC and McDonald’s) and trademarks of tangible nature |
Financial Account
Net direct investment: The purchase, setting up or expansion of companies and assets in Australia by foreigners classified as credits (the inflow of funds and assets) minus similar investments overseas by Australian residents classified as debits (the outflow of funds or liabilities) |
Net portfolio investment: The difference in the value of transactions by foreign individuals purchasing Australian shares (credits), debt and securities minus the value of similar assets purchased by our residents (debits) |
Commons sense stuff…
Balance on Merchandise Trade |
Exports of Goods - Imports of Goods |
Net services |
Export of Services - Import of Services |
Net Income |
Primary income credits - Primary income debits |
Current Account Surplus
Total value of credits is greater than the total value of debits measured over a period of time
Current Account Deficit
Total value of debits exceeds the total value of credits measured over a period of time
Net Income Balance
Net Primary Income ONLY
Primary Income credits - Primary Income debits
Excludes secondary income as it is not related to productive capacity
Cyclical Factors
Fluctuations in the current account that result from changes in the business cycle or economic conditions, usually short-term or temporary
The strength of the economies of international trading partners
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Structural Factors
Long-term, underlying features of an economy which tend to be persistent and shape the overall competitiveness, investment patterns and trade behaviour of a country overtime
Difference between the national savings and the national investments in an economy
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Model Answer
Structure:
Define the factor
Refer to any graphic data given (last 2 years) to explain the influence of the factor on the Current Account
Explain whether this impacts debits or credits
Link to CAD or CAS
Overseas growth
Overseas growth refers to the strength of the economies of international trading partners. Over the last two years overseas growth has remained relatively stable at approximately 3%. This is likely to have had a minimal effect on Australia's Balance of Payments, all other factors remaining constant. Typically, overseas growth would impact demand for Australian made goods and services, affecting the Current Account Balance
Savings/Investment
Savings/Investment imbalance refers to the difference between the national savings and the national investments in an economy. Post COVID consumption increased rapidly throughout 2023 as economies reopened to global trade before declining as a result of high inflation and high interest rates and declined steadily up to 2024. Australia has traditionally had a low national savings rate relative to its investment needs predisposing it to higher credits than debits and a structural Current Account Deficit. These factors contributed to an erosion of Australia’s Current Account Balance and a heavier reliance on foreign investment in the period of 2022-2024.
Net Foreign Debt
The difference between what Australia has borrowed from and owes overseas less what Australia has lent abroad and is owed
Net Foreign Equity
The difference between the value of foreign-owned Australian assets (such as property, shares and the retained earnings of owned companies operating here) less the value of overseas assets owned by Australian residents
Distinguish between net foreign debt and net foreign equities
Foreign debt comes with an obligation to repay interest which is recorded as primary income debit, foreign equity does not necessarily come with an obligation, although dividends might be paid which are also recorded as a primary income debit
Official Debt (Public)
Debt that is owed by governments
Non-official Debt (Private)
Debt owed by households and businesses
Higher than official debt
Main causes of Australia’s NFD
Lack of domestic savings:
Savings-investment gap contributes to a higher relative interest rate in Australia due to lack of available funds. This means that Australian borrowers are more likely to borrow from overseas, contributing to capital inflow and a higher net foreign debt.
Many budget deficits:
In recent years both Federal and state governments require funding in the form of borrowing. As just discussed, higher relative interest rates in Australia encourage borrowing from overseas.
Opportunities for foreign investors:
Australia has many natural resources which allow foreign investors to earn a high return. This encourages capital inflow.
Sound economic, political and social climate:
Makes Australia an attractive investment opportunity for investment as we have a lack of domestic unrest and a well structured legal and political framework. This encourages capital inflow.
Am lower value for the Australian dollar:
Encourages capital inflow as it makes purchasing our assets cheaper in foreign current terms, while Australian businesses find it more expensive to purchase foreign assets in Australian dollar terms.
Financial sector deregulation and globalisation:
Makes Australian assets more attractive for foreign investors, encouraging capital inflow.
Costs and Benefits of NFD
Costs:
Economic hardship can occur if the burden of interest and principal repayments mean that we cannot afford crucial goods and services, and if governments need to raise taxes and reduce spending to pay down debt.
Loss of our credit rating may occur if our capacity to repay is weakened. This loss of credit rating may come with higher interest rates on future debt.
Weakening of our current account balance occurs as large net foreign debt owed abroad means that we have large primary income deficits. This can also in turn increase the supply of the AUD, depreciating it and weakening the purchasing power of the AUD.
Benefits:
Capital inflow allows for our savings investment gap to be overcome, and investment in crucial economic and social infrastructure that we would not otherwise be able to afford.
Cheaper interest rates overseas allows for financing of investment in Australia to occur at a lower cost should we finance it domestically. This has positive effects on our production costs and international competitiveness.
Terms of Trade (TOT)
The ratio of the weighted average price of Australian exports to the weighted average price of imports to Australia
Favourable movement in TOT
When the average price of exports rises relative to average price of imports, where there is a rise in the value of net exports or fall in the value of net imports, increasing AD
When referring to a trend on a graph say “favourable/unfavourable movement”
Unfavourable movement in TOT
When the average price of exports falls relative to average price of imports, where there is a fall in the value of net exports or rise in the value of net imports, decreasing AD
When referring to a trend on a graph say “favourable/unfavourable movement”
Model Answer
Describe how the favourable movement of the terms of trade in the December 2024 quarter may affect the achievement of price stability in 2025 (4 marks)
The goal of price stability is for the rate of inflation, as measured by changes in the consumer price index, of between 2-3%, per annum, on average over time. There has been a favourable movement in the terms of trade in the December 2024 quarter, rising 1.7%, seeing the weighted average price of exports rise relative to the weighted average price of imports. Injections in the form of exports will rise relative to leakages in the form of imports, seeing more spending on Australian made goods and services. Businesses will observe higher sales and respond by increasing production, and potentially increase prices if the economy is at the limits of spare capacity. As annual inflation is currently sitting at 2.4% to the March 2024 quarter, and is roughly within the target range, it might be the case that the economy can absorb the increased spending without putting too much pressure on inflation.
Describe how increases in production costs overseas will influence the terms of trade (TOT), referring to coal
A decrease in supply of coal globally will see the price of coal bid up. As coal is a major export of Australia this will see the weighted average price of exports rise relative to the average price of imports, which is a favourable movement in the terms of trade.
Assume Australia experiences an unfavourable movement in the terms of trade across a two-year period. Explain how this scenario might affect Australia's macroeconomic goal of strong and sustainable economic growth, and Australia's living standards.
Define Goal
Define favourable/unfavourable movement
AD side story + Data (In this case, Economic growth + Inflation rate)
Does it achieve the goal?
Living standards (Material + Non-material)
The goal of strong and sustainable economic growth refers to the fastest rate of economic growth, measured by changes in real GDP, that is consistent with both economic and environmental goals. An unfavourable movement in the terms of trade will see a fall in the weighted average price of exports relative to the average price of imports into Australia. This will see exporting firms see falling sales, exports will fall relative to imports and spending on Australian made goods and services will fall. Businesses might cut back on the production of goods and services and the current 0.6% rate of economic growth in the December 2024 quarter may become weaker. In addition, businesses who experience falling sales might reduce prices to encourage sales, reducing inflation even further below the 2.4% annual rate to March 2025. If inflation falls below the 2-3% target band this might indicate more sustainable economic growth however it might mean that the economy is operating below productive capacity. Material living standards might fall if this reduced economic growth sees households less able to access goods and services, with non-material living standards similarly negatively impacted if lower levels of production sees the derived demand for labour fall, with the resultant unemployment seeing fewer people benefiting from social connections at work.
More Model Answers
Explain one way in which the decline in the rate of economic growth of Australia's major trading partners may influence Australia's balance of payments on current account.
A decline in economic growth overseas will see less demand for our exports including commodities and services exports like tourism. Lower incomes and higher rates of unemployment will see major trading partners like China and the United States demand fewer Australian exports, seeing credits earned on exports fall relative to debits incurred on imports into Australia. This will see the balance on the current account weaken, which at the moment will see the current account deficit rise.
Explain one way in which the decline in the rate of economic growth of Australia's major trading partners may influence the value of the Australia dollar.
A decline in economic growth overseas will see less demand for our exports including commodities and services exports like tourism. Lower incomes and higher rates of unemployment will see major trading partners like China and the United States demand fewer Australian exports. As such, the demand for the Australian dollar by our trading partners will decrease relative to its supply, with the price of the AUD bid down in order to clear a glut of dollars on the foreign exchange markets. This will see the AUD depreciate and be worth less in terms of other currencies.
Effects of a movement in the terms of trade (TOT)
Current Account Balance, Inflation (If no spare capacity), Economic growth, Full employment, Living standards, Exchange rate = Direct Relationship
Exchange rate
The value of one currency in terms of another currency
Appreciation + Depreciation
Currency appreciates |
When one currency (E.g. AUD) will be able to be exchanged for more of another currency (E.g. USD) than previously |
Currency depreciates |
When one currency (E.g. AUD) will be able to be exchanged for less of another currency (E.g. USD) than previously |
Trade Weighted Index (TWI)
The average exchange rate for a basket of foreign currencies each weighted according to its relative importance for Australia’s trade
Effects of a change in the following on the value of AUD:
Relative interest rates:
Affect the desirability of investment in Australia, and hence the demand and the supply of the AUD on foreign exchange markets
Commodity prices:
Prices overseas buyers pay for Australian exports have a direct relationship with the amount of AUD they must first purchase as part of the transaction
TOT/Demand for exports and imports:
Overseas buyers who purchase our exports demand AUD in order to make their purchases, while Australian buyers who purchase imports must first supply the AUD to exchange for foreign currencies
Foreign investment:
In order to purchase Australian assets foreign investors must first purchase AUD
Relative rates of inflation:
Impact spending on exports/imports as cost of production would be impacted, increasing Australian made goods/services prices
Credit savings:
Evaluations of national and sub-national government’s capacity to repay debt into the future, affecting investments made by international investors
Speculation:
Buying and selling an asset in the hope of making capital gains, where the AUD is traded on foreign exchange markets and can be used by speculators who wish to make capital gains on their trades
Effects of a change in the value of the AUD
Inflation:
A depreciation of the Australian dollar typically leads to higher import prices, increasing cost-push inflation as the cost of imported inputs rises for domestic producers. Additionally, increased demand for domestic goods due to higher-priced imports may create demand-pull inflation. Conversely, an appreciation tends to reduce inflationary pressure by lowering the price of imported consumer goods and inputs.
Economic growth:
A lower dollar makes Australian exports more competitive, boosting net exports, aggregate demand and thereby increasing real GDP growth. It may also encourage domestic tourism and import substitution, further stimulating growth. However, an appreciation can weaken export competitiveness and reduce growth, especially in trade-exposed sectors.
Full employment:
When the Australian dollar depreciates, export industries and import-competing firms may expand production and hire more labour, reducing cyclical unemployment. Increased economic activity from stronger net exports can lead to improved employment outcomes. On the other hand, an appreciation can lead to job losses in trade-exposed industries, potentially increasing unemployment.
Living standards:
A weaker dollar may reduce material living standards in the short term by increasing the cost of imported goods, leading to lower purchasing power for households and deteriorating non-material living standards as there is more financial stress. However, it may also lead to higher employment and national income over time, which can offset the cost pressures. An appreciation improves purchasing power and access to cheaper imports, enhancing material living standards but potentially at the cost of reduced domestic job opportunities and non-material improves as those employed have more social connections and greater self-worth.
Current Account Balance:
Depreciation of the Australian dollar improves the net goods and services balance by increasing exports and reducing imports due to price competitiveness. This may help decrease the Current Account Deficit Australia is currently facing (2025 quarter). Conversely, an appreciation can worsen the Current Account by encouraging imports and reducing the competitiveness of exports, increasing the Current Account Deficit.
Model Answer
Explain one way in which the decline in the rate of economic growth of Australia's major trading partners may influence Australia's balance of payments on current account.
A decline in economic growth overseas will see less demand for our exports including commodities and services exports like tourism. Lower incomes and higher rates of unemployment will see major trading partners like China and the United States demand fewer Australian exports, seeing credits earned on exports fall relative to debits incurred on imports into Australia. This will see the balance on the current account weaken, which at the moment will see the current account deficit rise.
Explain one way in which the decline in the rate of economic growth of Australia's major trading partners may influence the value of the Australia dollar.
A decline in economic growth overseas will see less demand for our exports including commodities and services exports like tourism. Lower incomes and higher rates of unemployment will see major trading partners like China and the United States demand fewer Australian exports. As such, the demand for the Australian dollar by our trading partners will decrease relative to its supply, with the price of the AUD bid down in order to clear a glut of dollars on the foreign exchange markets. This will see the AUD depreciate and be worth less in terms of other currencies.
A NOT B as Australian investors would be inclined to invest in the U.S. (capital outflow), exchanging AUD for USD, increasing supply for AUD = Depreciation
International competitiveness
The ability of Australian businesses to sell goods and services profitability at a price near to or lower than that of overseas competitors
Ways by which local/domestic producers try to compete with their international competitors
Competitive selling price:
Final selling price that buyers pay for goods/services, where most consumers compare the local price against similar items made abroad, so firms need to maximise efficiency in their use of resources so they can keep their production costs and prices down
Attractive non-price factors:
International competitiveness and consumer decisions are influenced by other factors, disregarding selling prices
E.g. Quality of good/service, Satisfying changing needs of consumers, Being innovative and coming up with new ideas/products, Superior customer service
Labour productivity
The output produced per unit of labour input, measured by real GDP per hour worked, reflecting how efficiently labour is used in the production process
Multifactor productivity
Represents a measure of the overall or combined efficiency of labour, capital and other resources
Factors that influence Australia’s international competitiveness
Wage rates:
Affects the cost of production for domestic businesses, and in turn, the prices for Australian made goods and services. Thus, differences in wages compared to other countries can influence the competitiveness of Australian exports and the attractiveness of imports.
Productivity:
The ratio of outputs to a given level of inputs, and is an aggregate supply factor that influences the willingness and ability of Australian businesses to produce goods and services. Higher rates of productivity growth mean that Australian businesses can profitability reduce their selling prices and compete better on price with our overseas competitors. It can also help to improve any structural weaknesses in the current account.
Availability of (natural) resources:
Affects the price of inputs for many businesses and hence their ability to compete with our international competitors. As Australia has abundant natural resources in the form of iron ore, coal, natural gas and other minerals, Australia has the ability to sell these resources at a competitive price compared to overseas nations.
Exchange rates:
Affect the price of Australian exports in foreign currency terms, as well as the price of imports in AUD terms which in part determines our ability to compete on price with our overseas competitors. For instance an appreciation of the AUD means that Australian exports are more expensive in foreign currency terms, while imports are cheaper in AUD terms. This negatively affects our international competitiveness.
Relative rates of inflation:
Influences the ability of Australian businesses to compete on price with our overseas competitors. For instance lower relative rates of inflation in Australia compared to our overseas competitors will tend to make Australian goods and services cheaper and increase our international competitiveness.
Innovation and research and development (R&D):
Levels of innovation and education influence Australia’s international competitiveness by shaping the ability of businesses to develop new products, improve production methods, and respond to changing consumer demands. Higher investment in research and development can enhance productivity and competitiveness.
Company tax rates:
Affects firms after-tax profits and pricing decisions, where higher company tax rates compared to trading partners can increase overall businesses costs, making it more difficult for Australian businesses to compete on price.
Government subsidies:
Government subsidies influence Australia’s international competitiveness by helping reduce production costs for domestic businesses, allowing domestic businesses to offer goods and services at a more competitive price in both domestic and global markets.
Effects of a change in Australia’s international competitiveness on the following…
Inflation:
Lower competitiveness causes our production costs and prices to be higher than in some other countries. Businesses pass on these extra costs as higher prices for the goods and services we purchase.
Economic growth:
Lower competitiveness than other countries makes it harder for local firms to sell their goods and services domestically and in export markets overseas. With lower sales and profits, many firms are less willing and able to expand their operations, in turn limiting the growth in Australia’s productive capacity and potential GDP growth.
Full employment:
Because many Australian businesses have higher production costs due to lower competitiveness, they have lower profits compared to their counterparts abroad. This means that some firms will close down or relocate overseas where aggregate supply conditions are more favourable, increasing structural unemployment.
Living standards:
Material - Lower international competitiveness can slow GDP and income growth, reducing the average quantity of goods and services consumed per person.
Non-material - Slower growth may reduce environmental harm, but higher unemployment could cause those to lose social connections and self worth tied with having a job.
Model Answer
Distinguish, using an example of each, between the cyclical and structural causes of Australia’s current account deficit
Australia currently has a current account deficit, which means that the value of debits incurred on goods, services, primary and secondary incomes exceeds the credits received on those same accounts in the current account of the balance of payments. Cyclical causes are those which are influenced by changing levels of spending on Australian made goods and services, net exports and the balance on the current account in the short term. These might include slowing levels of growth in major trading partners like China and sees less spending on Australian exports. Structural causes are those aggregate supply factors that cause our costs of production and international competitiveness to change, which in turn affect the balance on the current account over the longer term. For instance a fall in labour productivity, falling outputs per hour worked will see higher per unit production costs passed on in the form of higher selling prices which will see Australian's favour foreign imports and falling exports due to lack of international competitiveness. Both weaker overseas growth and lower labour productivity will see a fall in the credits earned on exports relative to the debits incurred on imports, weakening the current account balance. They differ in that structural causes are present regardless of our location on the business cycle, while cyclical causes fluctuate as economic activity within and outside Australia fluctuates.