UNIT 3AOS3 - AUSTRALIAN AND THE INTERNATIONAL ECONOMY

KK1: the gains from international trade, including lower prices, greater choice, access to resources, economies of scale, and increased competition and efficiency 

1.1: outline the concept of international trade

International Trade (Short Dot Points)

• Exchange of goods, services and capital between countries.

• Includes exports (sold overseas) and imports (bought from overseas).

• Improves living standards by increasing choice and income.

• Encourages competition, innovation and new technology.

• Gives businesses access to larger markets.

• Allows firms to achieve economies of scale and lower costs.

• Lower costs can lead to lower prices for consumers.

• Imports provide access to cheaper and higher-quality products.

• Exports increase demand, employment and economic growth.

• Australia has a competitive advantage in resources such as iron ore.

financial capital flows

• Australian firms rely on borrowing money from overseas to fund expansion

• Adds to stock of net foreign debt

human capital flows

• Globalisation has increased the international movement of labour

• Skilled foreign labour can alleviate capacity constraints

• Improves the quality of human capital allowing goods and services to be produced more cheaply/better quality

1.2: gains of international trade

lower prices, greater choice, access to resources, economies of scale and increase competition & efficiency.

lower prices (gain)

Increased trade and competition can reduce production costs and prices, increasing consumers’ purchasing power and material living standards.

greater choice (gain)

Consumers gain access to a wider variety of imported goods and services, improving quality of life and satisfaction.

access to resources (gain)

Businesses can access cheaper raw materials, labour, technology and capital from overseas, improving productivity and efficiency.

economies of scale (gain)

Businesses producing for larger global markets can increase output and lower average production costs.

increased competition and efficiency (gain)

Exposure to international competition encourages businesses to innovate, reduce costs and improve product quality, leading to a more efficient allocation of resources.

1.3 : use data and statistics (real or hypothetical) to explain how international trade enables all of the gains.

1.4 definitions

define exports

Goods and services produced domestically and sold to overseas consumers.

define imports

Goods and services purchased from overseas producers and brought into Australia.

define competitive advantage

When a business or country can produce a good or service more efficiently or at a lower opportunity cost than others.

define economies of scale

Cost advantages gained when production increases, causing average costs per unit to fall.

define savings

Disposable income that is not spent on consumption.

define investment

Spending by businesses on capital goods such as machinery, factories and technology to increase future productive capacity.

define net foreign debt (nfd)

The difference between Australia’s foreign debt liabilities and foreign debt assets.

define net foreign equity (nfe)

The difference between foreign ownership of Australian equity assets and Australian ownership of overseas equity assets.

KK2: the balance of payments and its components

2.1: explain how the balance of payments works.

• All financial transactions with the rest of the world are recorded in the BOP

• data used in recording bop is from abs

• it is a useful accounting summary of the areas where money is recieved from other countries and where australia spends money in the rest of the world.

• It essentially shows all of Australia's international transactions. When an item is recorded in it, its categorised into separate accounts and recorded as either a debit or a credit.

credits and debits (bop)

Credit: whenever money is received (the movement of money from foreign countries to Australia). These are shown as positive entries in the accounts.

Debit: whenever money is outlaid (the movement of money from Australia to foreign countries). These are shown as negative entries in the accounts.

2.2- You can outline each component of the balance of payments.

• it comprises two major sets of accounts: the Current Account (CA) and the Capital and Financial Account (CAFA).

• Each of the these accounts will have a positive or a negative balance and, at the end of any particular period, any CA deficit (CAD) must be exactly offset by a CAFA surplus, such that the BOP must equal zero. Similarly, any current account surplus needs to be offset by a CAFA deficit.

structure of the balance of payments

2.3- You are able to describe the difference between the current account and the capital & financial account.

• The Current Account (CA) records transactions of a current nature, meaning transactions that do not create future obligations. It includes trade in goods and services, income flows, and transfers between countries.

• The Capital & Financial Account (CAFA) records transactions of a capital nature, meaning transactions that create future obligations or involve the movement of assets and liabilities between countries. It includes borrowing, lending, and investment flows.

For example:

• Exporting iron ore is recorded in the Current Account because no future obligation is created.

• Borrowing money from an overseas bank is recorded in the Financial Account because the loan must be repaid in the future.

2.4- You are able to explain each of the main components of the balance of payments.

main component 1# balance of payments

1. Current Account (CA)

Balance on Merchandise Trade (BOMT)

• Exports of goods minus imports of goods.

• Includes products such as iron ore, coal, cars, TVs and medicines.

Net Services

• Exports of services minus imports of services.

• Includes tourism, education, banking and insurance.

Net Primary Income (NPI)

• Income earned from foreign assets minus income paid on foreign liabilities.

• Includes dividends, profits and interest payments.

Net Secondary Income (NSI)

• One-way transfers where nothing is expected in return.

• Includes foreign aid, gifts and pensions.

main component 2# balance of payments

2. Capital & Financial Account (CAFA)

Capital Account

• Records capital transfers and sales/purchases of non-produced assets such as patents or copyrights.

Financial Account

Records investment flows between Australia and overseas. It includes:

• Net Direct Investment – investment giving control of 10% or more of a company.

• Net Portfolio Investment – buying shares or bonds with less than 10% ownership.

• Financial Derivatives – transactions involving financial contracts such as futures or options.

• Net Other Investment – loans, trade credit and other financial flows.

• Net Reserve Assets – RBA transactions involving foreign currency reserves.

2.5- You can identify the reasons why the balance of payments must be zero.

The Balance of Payments must always equal zero because every international transaction has two equal sides:

• a credit entry

• and a debit entry.

If Australia has a Current Account deficit, it must be financed by a Capital & Financial Account surplus through borrowing or selling assets to foreigners.

If Australia has a Current Account surplus, there will be a Capital & Financial Account deficit because Australia is lending to foreigners or purchasing foreign assets.

equation of balance of payments

current account + capital account + financial account + net errors & omission = 0

2.6: definitions

define balance of payments

A record of all financial transactions between Australia and the rest of the world over a period of time.

define credit

Money flowing into Australia.

define debit

Money flowing out of Australia.

define current account (CA)

Records transactions of a current nature, including trade in goods and services, income flows and transfers.

define Capital & Financial Account (CAFA)

Records transactions involving capital transfers and financial investment flows between Australia and the rest of the world.

define Balance on Merchandise Trade (BOMT

The value of exports of goods minus the value of imports of goods.

define Balance on Goods and Services (BOGS) / Trade Balance

the combined total of the Balance on Merchandise Trade and Net Services.

define net services

The value of exports of services minus the value of imports of services.

define net primary income (NPI)

Income earned from foreign assets minus income paid on foreign liabilities. (labour)

define Net Secondary Income (NSI)

One-way transfers between countries where nothing is expected in return. (gifts)

define capital account

Records capital transfers and transactions involving non-produced, non-financial assets such as patents and copyrights.

define financial account

Records flows of financial assets and liabilities between Australia and the rest of the world.

define net portfolio investment

Investment involving less than 10% ownership or control of a company, including shares and bonds.

define net direct investment

Investment involving ownership or control of 10% or more of a company.

define financial derivaitves

Financial contracts such as options, swaps and futures that create assets or liabilities.

define net other investments

Other financial flows such as loans and trade credit that do not fit into other categories.

define net reserve investments

Transactions by the Reserve Bank of Australia and government involving foreign currency reserves.

KK3: Cyclical and structural influences on Australia’s current account balance

define: Structural influences on Australia’s current account balance

Structural influences are long-term factors that affect the current account even when the economy is operating at its trend growth rate.

Structural influences on Australia’s current account balance

• Australia often had CADs because investment > savings, requiring foreign borrowing.

• High foreign debt led to large interest payments overseas (NPI debits).

• Low productivity reduced export competitiveness.

• Reliance on commodity exports made the CA vulnerable to price changes.

• Higher national savings since 2019 improved the CA.

• Mining boom production phase reduced investment demand, improving the CA.

• Lower AUD increased export competitiveness.

• Structural improvements are long-term changes to the economy.

define Cyclical influences on Australia’s current account balance

are short-term changes in the CA caused by movements in the economic cycle.

Cyclical influences on Australia’s current account balance

• Strong spending increases imports, worsening the CA.

• Weak growth reduces imports, improving the CA.

• COVID-19 reduced imports and tourism spending, improving the CA.

• Strong global growth increases demand for Australian exports.

• Higher commodity prices since 2019 boosted export income and the CA.

• Lower global interest rates reduced foreign debt repayments.

• Higher interest rates and mining dividends worsened the NPI deficit.

• Cyclical improvements are temporary and linked to economic conditions.

KK4: the composition and cause of net foreign debt and net foreign equities

Composition and causes of Net Foreign Debt (NFD)

• NFD = debt owed to foreigners − debt owed by foreigners to Australia.

• Largest part of Australia's net foreign liabilities (NFLs).

• Builds up when Australia runs CADs.

• CADs occur when spending exceeds income, requiring foreign borrowing.

• Borrowing mainly through loans and bonds.

• Used to fund mining, infrastructure and business investment.

• Causes ongoing interest payments to foreigners (Net Primary Income).

• Creates the cycle: CAD → higher NFD → higher income outflows.

Composition and causes of Net Foreign Equity (NFE)

• NFE = foreign equity assets owned by Australians − Australian assets owned by foreigners.

• Includes shares, property and business ownership.

• Can be positive or negative depending on asset ownership.

• Australia has had positive NFE since about 2013.

• Growth driven by overseas investments, especially by super funds.

• Higher national savings increased foreign asset purchases.

• Affected by global share market value changes.

• Lower risk than NFD because equity has no fixed repayments.

KK5: The exchange rate, its meaning and measurement and the factors affecting its value, including relative interest rates, commodity prices and the terms of trade, demand for exports and imports, foreign investment, relative rates of inflation, credit ratings and speculation

define exchange rate

is the value (price) of one currency in terms of another currency, showing how many units of foreign currency can be purchased with one Australian dollar (AUD)

The exchange rate: meaning and measurement

• In Australia it is commonly measured against the US dollar (AUD/USD) or using the Trade Weighted Index (TWI), which is an average value of the AUD against a basket of major trading partner currencies weighted by trade importance. Since 1983, Australia has had a floating exchange rate, meaning its value is determined by demand and supply in the foreign exchange market.

• An appreciation means the AUD buys more foreign currency, while a depreciation means it buys less. The exchange rate changes continuously due to global trade, investment flows and speculation.

Factors affecting the value of the exchange rate

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• relative interest rates, commodity prices and the terms of trade, demand for exports and imports, foreign investment, relative rates of inflation, credit ratings and speculation

Exchange rate (meaning and measurement)

• The exchange rate is the value of the Australian dollar (AUD) in terms of another currency, most commonly the USD or the Trade Weighted Index (TWI).

• It shows how much foreign currency one AUD can buy. It is measured as AUD/USD or the TWI, which is a weighted average of Australia’s major trading partner currencies. Since 1983, it floats and is determined by demand and supply in the foreign exchange market.

Determination of the exchange rate (demand and supply)

• The exchange rate is set where demand for AUD equals supply of AUD in the foreign exchange market.

• Demand for AUD comes from foreigners needing AUD (exports, income flows, investment into Australia).

• Supply of AUD comes from Australians needing foreign currency (imports, overseas investment, income payments).

• An increase in demand or decrease in supply causes an appreciation, while a decrease in demand or increase in supply causes a depreciation.

relative interest rates (capital flows)

• If Australian interest rates are higher than overseas rates, foreign investors bring capital into Australia to earn higher returns. This increases demand for AUD and causes an appreciation.

• If Australian interest rates are lower than overseas rates, capital flows out of Australia, increasing supply of AUD and causing a depreciation.

terms of trade (TOT)

• An increase in the terms of trade raises export prices relative to import prices, leading to an appreciation of the AUD. A fall in commodity prices or TOT leads to depreciation.

demand for exports

• An increase in global demand for Australian exports increases demand for AUD as foreigners must convert their currency to buy Australian goods and services.

• This leads to an appreciation of the AUD. A fall in export demand reduces demand for AUD and leads to depreciation.

demand for imports

• An increase in Australian demand for imports increases supply of AUD in the foreign exchange market because Australians must convert AUD into foreign currency.

• This leads to depreciation of the AUD. A fall in import demand reduces supply of AUD and supports appreciation.

Foreign investment (capital inflow and outflow)

• Foreign direct investment and portfolio investment into Australia increase demand for AUD as foreign investors convert currency to invest in Australian assets. This leads to appreciation.

• Australian investment overseas increases supply of AUD and leads to depreciation.

relative rates of inflation

• If Australia has higher inflation than other countries, Australian goods become less competitive, reducing export demand and increasing import demand.

• This reduces demand for AUD and increases supply, causing depreciation. Lower inflation improves competitiveness and leads to appreciation.

credit ratings

A high credit rating (e.g. AAA) increases investor confidence in Australia, encouraging foreign investment and capital inflow. This increases demand for AUD and leads to appreciation. A downgrade in credit rating reduces confidence and can cause depreciation.

currency speculation

Speculators buy AUD if they expect it to rise in value and sell AUD if they expect it to fall. If expectations are positive, demand for AUD increases and the currency appreciates. If expectations are negative, supply increases and the AUD depreciates.

commodity prices

• Higher commodity prices increase export revenue for Australia, especially for resources like iron ore and coal. This increases demand for AUD as export earnings are converted into Australian currency.

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KK6: the terms of trade, its meaning and measurement and the factors that may affect the terms of trade, including commodity prices and production costs in trading partners

define terms of trade

measures the average prices received for Australian exports relative to the average prices paid for imports. It is measured using an index:

terms of trade equation

Terms of Trade Index= export Price Index / import Price Index ×100

terms of trade meaning

An increase in the TOT means export prices have risen relative to import prices, allowing Australia to purchase more imports for a given quantity of exports. A fall in the TOT means Australia can purchase fewer imports from export earnings.

factors that may affect the terms of trade

• commodity prices

• production costs in trading partners

commodity prices

Australia exports large amounts of commodities such as iron ore, coal and natural gas. Rising world commodity prices increase export prices and improve the TOT. Falling commodity prices reduce export prices and worsen the TOT.

Global demand for exports

Higher global demand for Australian exports increases export prices and improves the TOT. Strong growth in countries like China and India increased demand for Australian resources and caused major TOT booms.

global supply of exports

An increase in global supply of commodities lowers export prices and worsens the TOT. Supply disruptions in countries like Brazil or South Africa can reduce global supply and increase Australian export prices, improving the TOT.

producution costs in trading partners

Lower production costs in trading partners reduce the prices of imports into Australia, improving the TOT. Productivity growth and technological advances in countries like China lowered manufacturing costs and import prices.

technology and productivity growth

Technological improvements globally can reduce production costs and lower prices of imported goods, improving the TOT. Productivity growth in Australian export industries can also improve competitiveness.

demand for imports

Higher global demand for imports Australia buys can raise import prices and worsen the TOT. Lower demand for imports can reduce import prices and improve the TOT.

supply of imports

An increase in global supply of imported goods lowers import prices and improves the TOT. Supply shortages or disruptions raise import prices and worsen the TOT.

exchange rate movements

Changes in the exchange rate can influence the TOT depending on the currency exports and imports are priced in. A depreciation may improve or worsen the TOT depending on whether exports/imports are denominated in AUD or foreign currency.

wars and global disruptions

Wars, natural disasters, or supply chain disruptions can reduce global supply of commodities and increase export prices, improving Australia’s TOT. The war in Ukraine increased prices for coal, gas and other commodities.

oil prices

australia is a net importer of oil. Rising world oil prices increase import prices and place downward pressure on the TOT. Falling oil prices improve the TOT.

Effects of a higher TOT on economic growth and living standards

A higher TOT increases national income and purchasing power, boosting real Gross Domestic Income (GDI). This increases consumption, investment, economic growth and material living standards.

Effects of a higher TOT on employment

Higher export incomes encourage businesses to expand production and investment, increasing demand for labour and reducing unemployment.

Effects of a higher TOT on inflation

If TOT rises because export prices increase, higher national income and demand can create inflationary pressure. If TOT rises because import prices fall, production costs decrease and inflationary pressure may ease.

Effects of a higher TOT on the current account balance

A higher TOT usually improves the current account balance because export incomes rise and import prices may fall, improving the Balance on Goods and Services (BOGS).

KK7: international competitiveness and the factors that may affect international competitiveness, including productivity, production costs, availability of natural resources, exchange rates and relative rates of inflation

define international competitiveness

australia’s ability to compete in global markets through lower prices and/or higher quality goods and services compared to overseas producers.

productivity

• Productivity = output per unit of input (output ÷ inputs).

• Higher productivity lowers average production costs, allowing firms to lower prices or improve quality.

• Greater efficiency improves Australia’s international competitiveness.

• Productivity gains are more likely to improve competitiveness in highly competitive markets, where firms pass cost savings onto consumers.

• Governments encourage competition and microeconomic reform to increase productivity and efficiency.

• Low productivity growth reduces competitiveness because production costs rise relative to overseas producers.

production costs

• Lower production costs improve competitiveness because firms can produce more cheaply.

• Major production costs include labour costs, capital costs and raw material/energy costs.

• Rising wages, electricity prices or raw material costs increase prices and reduce competitiveness.

• Lower labour costs in Australia in recent years helped reduce inflationary pressure and improve competitiveness.

• Advances in technology have reduced capital costs and improved capital productivity.

• Rising electricity and energy prices have negatively affected competitiveness for many Australian businesses.

availability of natural resources

• Australia has strong comparative advantages due to abundant mining and agricultural resources.

• Large supplies of iron ore, coal, gas and agricultural land allow Australia to produce exports relatively cheaply.

• Investment in exploration and infrastructure improves resource availability and competitiveness.

• Climate change, droughts and natural disasters can reduce resource availability and lower competitiveness.

• Depletion of resources over time may reduce Australia’s comparative advantage.

exchange rates

• A depreciation of the AUD improves international competitiveness because Australian exports become cheaper overseas and imports become more expensive domestically.

• An appreciation of the AUD reduces competitiveness because exports become more expensive and imports cheaper.

• Floating exchange rates help stabilise competitiveness automatically.

• If Australia becomes less competitive, reduced demand for AUD tends to cause depreciation, helping restore competitiveness.

• Governments and central banks may occasionally intervene in foreign exchange markets to reduce volatility.

• Exchange rate movements overseas also affect Australia’s competitiveness.

Effects of international competitiveness on macroeconomic goals

• Improved competitiveness increases exports and aggregate demand, supporting economic growth.

• Higher competitiveness increases demand for labour and reduces unemployment over time.

• Lower prices improve price stability and help achieve low inflation.

• Productivity-driven competitiveness supports “low inflationary growth” where economic growth occurs without major inflationary pressure.

• Structural reforms may increase structural unemployment in the short term as industries restructure.

• In the long term, stronger competitiveness increases real GDP per capita and improves living standards.