 GLOBAL INDEPENDENCE

The Australian economy

- Strong and resilient

- Largest mixed market economy in the world
- In 2010,
 Economic growth: 2.5%
 UE rate: 5.2% (one of the lowest in OECD)
- Low public debt
- Increase in business investment expectations
- In 2014, Australia GDP is USD 1.52 trillion
- 19th largest importer and exporter in the world.

Factors contributing to strong Australian Economy

1. Australia’s strong economic institutions

- Sound, stable financial and banking system
- No Australian bank collapsed or required a government bail-out during GFC
- 4/9 world top ranking are Australian
2. Australia’s flexibility
- Open trade and investment environment
- Well-targeted economic policies supporting business growth and innovation
3. Australia’s close trade and economic links with the emerging economies of Asia (China and
India)
- Helps to support growth and employment.
- By 2010
 World trade growth was 18.8%
 Australia’s exports to China increase 34%
4. Sound macroeconomic policies
- Monetary policy – tax and Govt. spending
- Fiscal Policy – money supply and interest rates

OPPORTUNITY FOR AUSTRALIA’S TRADE

1. Mining
 Rise in world minerals’ price
 Rise of domestic investment and foreign investment
 Rise in export volume – close to developing countries, a lot of mining resources needed
 Mining in Australia
- Significant primary industry
- Contributor to Australian economy
- Encouraged immigration to Australia
- Large number of MNC mining,
BHP Biliton, Newcrest, Rio Tinto
2. Agriculture
 High end agriculture products – fruits, vegetable, dairy, farming
 Major export: Beef & Wheat
CHALLENGES
1. Protecting Australia sound macroeconomic policies through
- Medium term approach to fiscal and monetary policy
- Market determined exchange rate
- Reliance on market determined price signals
2. Future growth of living standard will be driven by productivity growth through
- Each business to improve productivity
- Government to create environment for productivity improvement
3. Traits needed to build Australia’s comparative advantage in world trade
- Soft skills, cultural literacy, investment in policy and infrastructure

LINKAGE BETWEEN ECONOMIES

1. INVESTMENTS
 Purpose:
To generate and capture benefits for Australia through investment liberalization
 The Foreign Investment and Trade Policy Division is responsible for ensuring effective
representation of Australia’s foreign investment policy and negotiating position on
international investment policy issues. – manages foreign investments
 Multilateral forums – Organizations for Economic Cooperation and Development (OECD)
o World Trade Organization (WTO)
 Regional Trade Agreement
o Asia-Pacific Economic Cooperation (APEC)
o ASEAN
 Bilateral forums
o Free Trade Agreement (FTA)
o Investment protection and promotion agreement (IPPA)
o AUS-CHINA
 Emerging eco EG ⇑ - NY ↑ - ↑ funds to invest - If AUS has FTA with
them (easy to invest) - Capital inflow ↑ - ↑ production - GDP/EG ↑
- Production: Purchase machines, factories → produce more products →
expand business

2. Tourism
 Purpose:
- Build Australia’s market share of targeted travellers through increasing demand
- Influence people to travel to and within Australia
- Maximise tourist spend and visitation throughout the country and deliver real economic
benefits to regional areas.
 Leisure – experience seekers
 Business events – corporate meetings, conferences and exhibitions
 School groups – short course English students and visiting friends and international
students
 Tourist from China - ↑ purchasing power - ⇑ developing country
 Emerging eco EG ↑ - NY ↑ - Travel to AUS – Expansion of tourism
industry - ↑ workers needed (labour intensive industry) EU ↓ @
tourism industry/F&B – Export ↑ - Trade ↑
 Tourist spending ↑ - other sectors expands – GDP/NY ↑
3. Immigration
 Aim: Build Australia’s future through the well-managed entry and settlement of people,
includes:
- Contributing to Australia’s future through managed migration
- Protecting refugees and contribute to humanitarian policy internationally
- Contributing to Australia’s security through management and traveller facilitation
- Making fair and reasonable decisions for people entering and leaving Australia
- Supporting migrants and refugees to settle in the community and participate in Australian
Society
 Fair border management – encourage skilled workers to enter AUS (Mining
& Agriculture) – productivity/efficiency ↑ - GDP/EG ↑

4. Trade
 Purpose:
- Economies do not produce all the items they need/less efficient
- New technology in transport & communications => reduce cost & improve services
- Government encourage trade => less barriers & more trade groups - ↑ FTA
- Create jobs, raises incomes, encourage business to be innovative
 Trend in direction of trade:
o Between 1995-2011, high income economies (North America & Western Europe)
global trade fall from 82% to 66%, East-Asia & pacific region 7%-15%
o Eg: China
 Important role in global trade
 Australia may respond by preparing for larger trading relationship with
China through
- Learning mandarin in schools
- Foster great trade ties with them
- Invest in high China’s demand industries
 Trading partner EG ↑ - Industrialization/urbanization – Demand for
commodities ↑ - Export ↑ - Total trade ↑ - GDP ↑
 Industrialization - mass production + cheap labour – cheaper import (AUS
import from China) – Total trade ↑ - GDP ↑
 Specialisation (AUS – Minerals) – produce based on OC – X excess + M
shortage – Total trade ↑ - GDP ↑
 China – industrializing to produce goods but china does not have a lot of raw materials such
as iron ore – hence they buy from AUS – increase AUS exports
Pattern of world trade

Most traded commodity: Crude Oil → Coffee

Most traded sector: Manufacturing → Agriculture → Mineral → Service

Changes in the pattern of global trade over time (after WW2)

1. ↑ Volume of capital movement, ↑ Foreign investment

= Trade liberalization/ deregulation of financial market → foreign
investment ↑ → ↑ capital investment than value of trade
2. Advancement of internet
= Customer buy online → Producer set up online stores (E-commerce) →
save cost & time → more brands more trading between countries
3. Increase in productivity
= Specialization → produce product → resources allocated efficiently
4. Fall in communism
= fall in close economy → Open up larger market for the world → ↑ trade
5. Advancement of transportation
= Cheaper and reliable / faster → transported faster and easier → trade
↑

Significance of US economy to global trade:

1. Size of US market ( growth of middle class income group → purchasing power)

2. Wealth of US economy (amount of assets owned)
3. Comparatively homogeneous culture ( everyone speaks ENG → trade easier)

Significance of China economy to global trade:

= Big population, ↑ demand, ↑ demand for world trade, ↑ production = ↓ price

1. Lower oil price

2. Falling commodity prices
3. Reduction in trade
4. Corporate domino effect/chain effect (effects one another)
 INTERNATIONAL COMPETITIVENESS (IC)

DEFINITION: The ability of a country to design, produce and market goods and services that are
better or cheaper than those of other countries.

AFFECTS:

1. International trade
2. National production
3. Employment
4. Income

DETERMINANTS:

1. Relative inflation rate (2-3%)

o Rate of increase in price over time

o Relative inflation rate ↓ - Price increase at slower rate –
Price of AUS g/s relatively cheaper – IC ↑

2. Relative wage rate

o Relative wage rate ↑- cost of hiring ↑ - COP(cost of

production) ↑ - burden pass down to consumer – price ↑
- IC ↓
o World highest min wages country : Australia (relatively higher)
o Relative unit labour cost – fix wage cost
o Non-wage cost – medical, dentist, mobile phone charges, insurance, training, epf

3. Productivity

o Efficiency level of production (output/input) due to training and technology and

education
o Productivity ↑ - COP ↓(achieve EOS) - Efficiency ↑ - Price ↓ -
IC ↑
o Most productive country 2015 : Australia No.14

4. Exchange rate

o Value of one currency against another

o AUD APP – Price of X ↑ in terms of foreign currency – DD
↓ - IC ↓
o AUD APP – price of imported or raw material ↓ (AUD)
(machines, technology) – COP ↓ - Price ↓ - IC ↑
o Facts about AUD compare to USD/NZ/UK/US

5. Lead time

o Time frame between order placement and deliverance

 o If lead time is relatively low
- Consumer satisfaction ↑ - IC ↑
- Producers (customers) does not need to pile up raw
material – reduce risk/cost of handling/warehousing
material – IC ↑

6. Tax rate and interest rate

o Interest rates ↓ - cost of borrowing ↓ - producers may take up

loan to invest in technology and expand business – COP ↓ -
May reduce price – IC ↑

7. Change in economy policies

o Encourage R&D spending

o Improve skill base - training – being equipped – more efficient – COP ↓
o Improve economic infrastructure
o Promote competitiveness between firms
o Operate macro-economic policies favourable to business expansion
o Reduce interest rate to stimulate investment
o Reduce tax to stimulate enterprise, effort and investment.
o Deregulation to promote competition –FTA – free movement of capital/foreign
invesment
o Encourage sharing of ideas and best practice
o Reduce protectionist barriers to stimulate competition – less tariff, quota – make
domestic market to be better to compete with international goods – efficiency ↑ -
price ↓ - IC ↑
 GLOBALIZATION

MEANING:

Process of international integration arising from the interchange of world views, products, ideas, and
other aspects of culture.

Economic indicators of globalisation

Measures of globalisation includes indicators on capital movements and foreign direct investments,
international trade, the economic activity of multinational firms and the internationalisation of
technology.

The economic indicators are:

a. Growth in trade
b. Foreign investment
c. Flows of people (migration of labout/tourism/immigration)
d. Growth in communication

Factors facilitating globalisation (START WITH FACTOR END WITH AFFECT)

1. Trade liberalisation

- Reduce of restrictions or barrier on free exchange of goods between nations.

- Removal or reduction of both tariff (duties and surcharges) and non-tariff obstacles (like
licensing rules, quotas and other requirements.)
- Growth in trade: Cheaper goods, demand increase for imported goods
- Growth in foreign investment: Leads to deregulation of financial market, remove/reduce for
foreign investors (Buy and sell shares easy)
- Growth in flow of people: more labour, includes visa application, ASEAN
 Free trade – reduce/remove trade barriers – cheaper to M/X (cost
of imported material ↓ - COP ↓ - GROWTH IN TRADE
 Free trade – deregulation of financial market – encourage capital
movement between countries – GROWTH IN FOREIGN
INVESTMENTS
 Free trade – encourage tourist from member countries (eg. Easier
visa application process, recognize qualification/education
standard of trading partners. – foreign tourist ↑ , foreign skilled
workers ↑ - GROWTH IN FLOW OF PEOPLE

2. Advancement in technology & communication

 Advancement of e-commerce platform (eg. Ebay) – Market base ↑

- DD X/M ↑ - GROWTH IN TRADE
 Productivity ↑ (efficient) – COP ↓ - DD X ↑ - GROWTH IN TRADE
  Allow investors to purchase shares over stock market (Allow
depositing of funds into foreign banks & manage through it
through e-banking) – GROWTH IN FOREIGN INVESTMENTS
 Cheaper/faster/more convenient to communicate across national
borders (eg. Email/whatsapp) – GROWTH IN COMMUNICATION
 Allow tourist to obtain info about tourist point abroad, labour to
find job opp abroad – GROWTH IN FLOW OF PEOPLE

3. Advancement in transportation system

- Cheaper safer to transport products – container

- Lead time shorter
- Everyone can travel
 Cheaper/safer to transport/deliver goods across countries (eg.
Using containers) – lead time ↓ , cost ↓ - GROWTH IN TRADE
 Cheaper/faster to travel between countries – foreign tourist ↑ /
foreign workers ↑ - GROWTH IN FLOW OF PEOPLE
 Allow investors to easily manage the investment across countries
– GROWTH IN FOREIGN INVESTMENTS

4. Growth in multinational corporations (MNC)

- Companies with HQ in one country and branches in other countries.

 Export products from factory (in one country) to other branches
around the world – movement of g/s between countries – GROWTH
IN TRADE
 Force domestic producers to be more innovative/ efficient to
compete – IC ↑ - DD X ↑ - GROWTH IN TRADE
 Invest in branches across national borders – capital movement ↑ -
GROWTH IN FOREIGN INVESTMENT
 Send expertise/manages to branches for
training/managing/marketing purpose – GROWTH IN FLOW OF
PEOPLE

ARGUMENT FOR & AGAINST GLOBALIZATION

POINTS FOR AGAINST

Economic growth Growth in economies of host Existence of social and
 countries
Living standards Improve living standard and
reduce poverty
Life expectancy increase
FDI Increase of FDI  accelerated
growth
Workplace standard Respect for ILO
Culture Respect for cultural identity
Environment Positive & spread awareness
Economic Powers (WTO) Resolve international political
and economic tension
Technology Reduce cost and price
Modern communication Growth in liberal democracies
economic costs
Reduce living standard
Decrease
Vulnerable to economic
problem
Brain-drain of skilled workers
Erode national culture
Harm & pollution
Work against the interest of
developing world
Destroying agricultural
communities and encourage
cheap import of manufactured
goods
Increased demand for
migration to richer countries
 AFFECTS OF GLOBALISATIONS
ADVANTAGES
1. Encourages countries to
specialise
2. Economies of scale: ↓
COP, ↑ Trade
3. Allow countries to have
comparative
advantage: ↑
productive and
allocative efficiency.
4. Lower COP: Lower Prices:
Greater choices
5. World GDP ↑: ↑
efficiency & output
6. Poverty ↓, UE ↓, new skills
and wealth: living
standards & income ↑
7. International
competiveness: ↓ price
8. Increase awareness of
international disasters and
consequences.
DISADVANTAGES
1. Price of some g/s rises.
Increasing world income has
resulted in an increase of
demand, when supply is
unable to meet demand,
prices rise.
2. Countries are
economically dependent
one each other. This can
lead to instability.
3. Global imbalance on the
balance of payments current
accounts. Some economies
are running large deficit
which is unsustainable.
4. Specialisation leads to
over reliance on a few
industries.
5. MNCs exploits developing
countries by paying lower
wages.
6. MNCs can force local
firms out of business
because they cant benefit
from economies of scale
and are less competitive.
7. MNCs can relocate easily and
cause massive
unemployment.
8. Influence government
policies in their favour,
unfair and unhelpful for
domestic companies.
9. Government may be forced
to reduce corporation tax to
attract businesses.
 ADVANTAGES OF GLOBALISATION

1. Stimulate economic growth

Trade ↑ - market base ↑ - DD X ↑ - production ↑ - GDP ↑ - EG ↑

FI ↑- invest in machinery and technology - production ↑- GDP ↑ - EG ↑
Migrants ↑ (skilled workers) – Productivity ↑ & Efficiency ↑- Production ↑ - GDP ↑ - EG ↑

Globalisation has helped many of the world's poorest countries to achieve higher rates of economic
growth and reduce the number living in extreme poverty – for example, significant progress has been
made in China and India and notable in a number of sub-Saharan African countries whose annual
growth of real GDP has often exceeded 10%.
2. Increase standard of living and reduce poverty

Trade ↑ - job opportunity ↑ - UD ↓ - HHY ↑ - Purchasing power ↑ - SOL ↑

FI ↑ - job opportunity ↑ - UD ↓ - HHY ↑ - Purchasing power ↑ - SOL ↑

India has cut its poverty rate in half in the past two decades. China has reduced the number of rural
poor from 250 million in 1978 to 34 million in 1999. Cheaper imports also make a wider range of
products accessible to more people and, through competition, can help promote efficiency and
productivity.
The OECD Growth Project found that a 10 percentage-point increase in trade exposure for a country
was associated with a 4% rise in income per capita over time.
3. Increase foreign direct exchange

Trade/F.I – NY of trading partners ↑ - more funds available to invest + FTA with AUS – FDI
inflow ↑
Trade ↑ - countries produce g/s with low OC to stay competitive – managing cost is
important – many more factories with lower labour cost/abundance of resources – FDI ↑

4. Share of information and technology

FI investing in domestic industries – introduce tech\machines used in home country (Ford
in Australia) – allow local (investor/labour) to learn new skills
Trade – allow domestic investors to M new tech to learn new skills (eg. Smartphone)
Migrants – share skill/information/ with locals as they work in the host country (Eg. Learn
about about automobile from Germans)
Communication – allow individual to learn new technology/skills from internet (eg.
Youtube)

5. Positive environmental outcome

Trade – export to tech to protect environment – cleaner water (water treatment), less
pollution (biodegradable bags, hybrid car, coca cola invented energy saving fridge)
Communication – learn to manage environment – recycle projects (Youtube/google)
DISADVANTAGES OF GLOBALISATION

1. Social & economic cost

Social cost: crime, health care // Economic cost: slowing down EG
Trade ↑ - market base for competition ↑, market base for less competitive economies ↓
- EG of less competitive economies ↓ - UE ↑ @ less competitive - UE benefit ↑ (which
could have been used for other purposes.)
FOP ↑ - more immigrants – taking locals jobs – UE ↑ - crime rate ↑ - Social cost ↑ (legal
related cost, medical expense.)

2. Standard of living

FOP ↑ - Skilled workers into AUS ↑ - locals lose jobs – UE ↑ - HHY ↓ - SOL ↓
Trade ↑ - Specialization (produce g/s with lower OC) – competitive industries ↑, less
competitive industries contract – structural UE ↑ - SOL ↓
Structual UE – miss-match between job available & skill available

3. Vulnerable to economic indicators

EG of other countries ↓ - DD X ↑ - Total Trade ↓ - Production ↓ - GDP ↓ - EG ↓

Tension between economies – affect the economies – EG of other countries ↓
(eg. Trade war between CH & US may affect AUS/MSIA)

4. Fasten destruction of environment

Trade ↑ – Demand ↑ - Production ↑ - Factories ↑ - Carbon emission ↑

F.I ↑ - MNC set up factories at developing countries - exploit weak environment policy –
pollution ↑ illegal waste ↑
FOP ↑ - migrants ↑ - lack of consideration/ respect towards host country’s environmental
care – littering

5. Brain drain affect

Trade – cut down COP – MNC factories move to developing countries – Job in developed
country decrease – skilled migrants to other countries
Comm ↑ - learn more about job opp w/ higher wage – migrate to do developed countries
– skilled workers in developing countries ↓
Gains from trade

1. Efficient allocation of resources ( entrepreneur, capital, land, labour)

Trade → specialisation in providing (hence exporting) g/s with CA (lower OC) → productivity ↑
(lesser input needed to produce amount of /some input produces larger amount of output.) →
Expansion of industry → more resources channelled to the industry → efficient allocation of
resources

2. Wider consumer choice

Trade → consumer exposed foreign g/s (M) → Wider choice → SOL ↑

Trade → competition between producers → price ↓ Quality ↑ → Purchasing power ↑ → wider

choices → SOL ↑

Trade → Job opp ↑ → UE ↓ → HHY ↑ → PP ↑ → Wider choice → SOL ↑

 3. Economies of scale

Fixed cost being produced out to larger quantity of output. (mass production)

Trade → wider market base → DD X ↑ → Production ↑ (mass production) → fixed cost averaged
out (assuming fixed cost remain unchanged.) → Achieve economies of scale

Trade → Specialisation (CA) → loss wastage/more efficient → COP ↓ while production ↑ → Achieve
EOS

4. Increase competition & prevention of monopolisation

Trade → allow import of foreign g/s → competition happens between imported g/s & import
competing industry → monopolisation avoided → producer power ↓ → consumer power ↑ → to
stay competitive, producers will reduce price, improve quality, innovative

5. Economic growth

Trade → market base expands → production↑ to support ↑ demand → GDP ↑ → EG ↑

Trade → Job Opp ↑ → UE ↓ → Consumption ↑ → GDP ↑ → E.G ↑

Trade → efficient allocation of resources → larger output with limited resources → GDP ↑ → EG ↑
 FREE TRADE AND PROTECTION
FREE TRADE
o International trade (imports and
exports) without government
restrictions
o Trade of goods and services without
trade barriers
PROTECTIONISM
 Protection of domestic industry against
foreign competition
 Government restrictions are placed on
the imports of foreign competitors
(tariffs, quotas and subsidies)

Why do nations trade?

Countries trade with each other when, on their own, they do not have the resources, or capacity to
satisfy their own needs and wants. By developing and exploiting their domestic scarce resources,
countries can produce a surplus and trade this for the resources they need.

THE SIGNIFICANCE OF INTERNATIONAL TRADE FOR THE AUSTRALIAN ECONOMY

1. The Australian economy has always relied on the international sector for imports and
exports and funds for investment.
 Australia is a world-class provider of a range of services, such as telecommunications,
travel, banking and insurance. The services sector is a significant part and represents
about 70% of Australia’s GDP and employs 4/5 Australians.
 Trade openness ratio or trade intensity ratio refers to the share of trade in GDP
 Trade openness = (X + M/GDP) x 100
*Australia’s trade intensity has increased significantly over the past few decades;
however, when compared to other developed economies, Australia’s trade intensity is
still low.

FACTOR THAT DETERMINE A COUNTRY’S TRADE INTENSITY

 Size of the economy
 Location relative to foreign markets
 The extent of trade barriers, both natural and artificial.

WHY AUSTRALIA’S TRADE INTENSITY IS LOWER THAN DEVELOPED COUNTRY’S?

 Australia has been lowering its artificial barriers such as tariff but hindered by more
natural barriers such as high transportation cost due to geographical isolation.
 Not being part of regional trade blocs such as the EU or ASEAN.
 The structure of Australia’s economy is different. = relies more on primary industries
(agriculture and mining) and less on manufacturing in terms of exports.

NATURAL TRADE BARRIERS ARTIFICIAL TRADE BARRIERS

Arises because of the firm’s technical Supported or enforced by the state or
characteristic economies
Technical barrier to entry. Legal barrier.
Contracting cost, negotiating cost, Tariff, quota, embargo
transportation cost.
FREE TRADE VS PROTECTION

FREE TRADE: (Trade liberalization) refers to unrestricted international trade.

PROTECTION: Policy of sheltering the domestic industries from foreign competition through the
imposition of trade barriers on foreign goods and services.

PROTECTION:

Refers to any action by the government designed to give the domestic producer an artificial
advantage over a foreign producer.

Types of protection:

Restrict quantity of imports Lower cost of domestic Increase the price of imports
producers
Quotas Subsidies Tariff
Embargoes, Licensing

DEADWEIGHT LOSS

 Known as excess burden or allocative inefficiency, is a loss of economic efficiency that

can occur when equilibrium for a good or a service is not achieved.
 In economics, a deadweight loss (also known as excess burden or allocative inefficiency)
is a loss of economic efficiency that can occur when equilibrium for a good or service is
not achieved or is not achievable.
 When deadweight loss occurs, there is a loss in economic surplus within the market.
Causes of deadweight loss include imperfect markets, externalities, taxes or subsides,
price ceilings, and price floors

Types of Protection:

TARIFFS

 Import tax which has been imposed on a good, which has passed a custom’s barrier.
 Tax paid by the importers.
 Tariff expressed as a percentage of the value of the value of the good or it may also be a
specific base.
 Most well-known barrier to trade and commonly used.
 Imposition of a tariff will increase the price of the good, thus will reduce the quantity of
imported goods.
 Provides tax revenue for the government.

TARIFF BARRIERS NON-TARIFF BARRIERS

- Import tariffs - Subsidies
- Export tariffs - Tied aids
- Transit tariffs - Minimum sale price
- Quotas
- Embargoes
- Buy – local legislation
- Specific permissions required
 THE IMPOSITION OF A TARIFF

THE EFFECTS OF A TARIFF

1. Demand(D) and supply (S) curves show the domestic demand and supply for cars
in Australia.
2. P1 is the domestic price and Q1 is domestic output
3. With free trade, Australian producers will be forced to sell cars at the world price
P2. By which they will supply at Q2.
4. But consumers will demand Q3, therefore imported cars make up the difference
between domestic supply and demand (Q3-Q2)
5. Suppose the government impose a tariff on imported cars equal to P2P3 per unit,
this will raise the domestic price to P3
6. Consumption of cars will decline from Q3 to Q4 (contraction of demand due to
higher price)
7. Domestic production will expand from Q2 to Q5 (Australian producers do not pay
the tariff, so they are able to supply more at a higher price.
8. The volume/quantity of imported cars will contract/decline from Q2Q3 to Q5Q4
(local car production displaces imports in Australian market)
9. The government will receive tax revenue (shaded area rectangle) which is equals
the tariff multiplied with the quantity of imports (P2P3 x Q5Q4)

• Domestic producers supply a greater quantity of

the good. Therefore, the tariff stimulates domestic
production and employment. • Reduced imports
and protected the domestic producers •
Redistribution of income away from consumers to
the government in the form of tariff revenue and to
the local producers (and workers) in the form of
increasing income earned. • Reduce the incentive
for local producers to adopt to the latest
innovations because supply is restricted to domestic
market instead of export markets) • Raise the price of cars to other domestic producers who
purchase cars as an input. • Directly promote the expansion of relatively inefficient industries (no
comparative advantage) and directly causes the fall in the business of relatively efficient industries
(that have comparative advantage)
QUOTA

An import quota controls the volume of a good that is allowed to be imported over a given period of
time. The quota guarantees domestic producers a
share of the market.

 The D and S represent domestic supply

and demand
 P is the price at which the imported goods
would sell if there was no quota imposed.
At this price consumers demand Q1,
domestic producers supply Q and the
quantity imported would be Q to Q1
 If the government imposed a quota restricting imports to Q2 to Q3, this would have the
effect of raising the price of imported goods to P1. This price would allow domestic
supply to expand to Q2

ECONOMIC EFFECTS OF QUOTA

• Domestic producers supply a greater quantity of the good. Therefore, the quota stimulates
domestic production and employment in the protected industry.

• More resources in that economy are attracted to the protected industry, leading to reallocation of
resources from other sectors of the economy (where production and employment will fall)

• Consumer pay a higher price and receive fewer goods. This redistributes income away from
consumers to domestic producers in the protected industry, results in lower overall levels of
economic growth.

• Quotas do not directly generate revenue for the government.

• Imposition of a quota on imports can invite retaliation from the country whose exports may be
reduced because of the quota. This can result in lower exports for the country that initiated the
import quota.
SUBSIDY

 Transfer payments from the government to industry to maintain industry’s government to

industry to maintain industry’s competitiveness in either domestic or foreign markets.
 Paid from general government revenue
 Reduce price of domestic products and make it difficult for the foreign producers to sell a
similar product in the home market.
 Will not reflect the true production cost.
 Subsidies include:
a. Direct payments
b. Other cash grants
c. Tax relief (tax holiday)
d. Cheap government loan

THE EFFECT OF A SUBSIDY

- D and S curves show the domestic demand and supply for a product.
- Without trade, domestic price is P1 and domestic output is Q1
- Producers will supply Q2 but consumers will demand at Q3, therefore imported similar products
make up the difference between domestic supply and demand (Q3 – Q2)
- Suppose that the government grants a subsidy, this encourages domestic producers to sell more
by lowering the price for consumers.
- Supply curve shifts downward to the right (S1 to S2)
- Domestic supply is at Q4 and the shortage is at Q3-Q4
- If the subsidy is large enough, the domestic price might fall below the world price thus
completely protecting the domestic producers.
 OVERALL ECONOMIC EFFECTS OF PROTECTION
 Reducing trade between nations
 Reduce living standards and reduce global economic growth by shielding inefficient
producers.
 Protectionist policies make it more difficult for individual economies to specialize in
production in which they are most efficient.
 The negative economic impact of the trading blocs tend to be the greatest for
developing economies which are excluded from access to the markets of advanced
economies.

PRO
• Infant industry argument
• The increase in Employment argument
• The anti-dumping argument
• The diversification argument
• The favourable balance of trade argument
• The national defence argument
• The cheap foreign labour argument
OPPOSE
• Inefficient resource allocation
• Misallocation of resources
• Inflationary effects
• Redistribution of income problem
• Reduced incentive to innovate
• Lower standard of living
• More foreign investment
• Economies of scale
FREE TRADE

 Policy by which governments do not discriminate against imports or exports.

 Exemplified by the European Union / European Economic Area and the North American Free
Trade Agreement, which have established open markets with very few restrictions to trade.
 Most nations today are members of the World Trade Organization (WTO) multilateral trade
agreements
 Most governments still impose some protectionist policies that are intended to support local
employment, such as applying tariffs to imports or subsidies to exports.
 Governments may also restrict free trade to limit exports of natural resources. Other
barriers that may hinder trade include import quotas, taxes, and non-tariff barriers, such as
regulatory legislation.

BENEFITS
- Increased economic cooperation
- Lower price
- Less government interference in the market
- More efficient production
COSTS
- Some nations cannot compete effectively
and remain poor
- Lower wages for workers = jobs are
outsourced to cheaper labour market
- Companies can move factories to areas
with fewer environmental standards

TYPES OF TRADES EXPLANATION

Bilateral Trade Agreement
Multilateral Trade Agreement
Regional Trade Agreement
- Between two countries
- Involves 3 or more countries who wishes to
regulate trade between the nations without
discrimination.
- Usually lower trade barriers
- Most effective way of liberalizing trade in
an interdependent global economy.
- Involves group of countries that are within
a geographical region.

BENEFITS
Increase in income/growth
Achieve economies of scale
Reduction of monopoly inefficiencies
Expands trade volumes among member
countries and tends to increase
incomes/growth of the members.
Allows country to specialize in the production
of the goods in which it has a comparative
advantage and trade those goods in exchange
for imports of other goods from another party.
Eliminating tariffs, expand county’s export
market thereby allowing it to expand its scale
of operations and lower its average cost of
production.
If inefficient monopolies exist in the domestic
market then increased competition from
foreign products will dampen domestic
monopoly or eliminate it.
 Availability of greater product variety Increases trade flow and expand the variety of
products available to consumers in the home
country.

BENEFITS OF FTAS TO AUSTRALIA

• FTAs foster freer trade flows and create stronger ties with our trading partners.

• FTAs don't just eliminate tariffs, they also address behind-the-border barriers that impede the flow
of goods and services between parties, encourage investment, enhance cooperation, and can
address other issues, such as intellectual property, e-commerce and government procurement.

• FTAs can increase Australia's productivity and contribute to higher GDP growth by allowing
domestic businesses access to cheaper inputs, introducing new technologies, and fostering
competition and innovation.

• FTAs promote regional economic integration and build shared approaches to trade and
investment, including through the adoption of common Rules of Origin and through broader
acceptance of product standards.

• FTAs can enhance the competitiveness of Australian exports in the partner market, and add to the
attractiveness of Australia as an investment destination.

• FTAs can deliver enhanced trading opportunities that contribute to the sustainable economic
growth of less-developed economies.

• FTAs can continue to provide benefits to parties as the agreements are implemented, including
through phase-ins and in-built agendas that encourage ongoing domestic reform and trade
liberalisation.

Selective protectionism Economic integration

Bilateral/unilateral trade agreement Free trade area, regional trade agreement,
Eg. FTA custom union, economic union, common
market
APEC, ASEAN, NAFTA, EU

FREE TRADE AREA

- Region encompassing a trade bloc whose member countries have signed a free trade agreement
(FTA).
- Agreements involves cooperation between at least two countries to reduce trade barriers –
import quotas and tariffs – and to increase trade of goods and services with each other.
- European Union, NAFTA (Canada, USA, Mexico)
FREE TRADE AGREEMENTS

Definition:

Sovereign nations join together, usually on a regional scale, to create free trade agreements.

Purpose:

Free trade agreements are created to lower trade barriers and stimulate trade between member
countries. Member countries belonging to the free trade area trade freely with each other while
maintaining trade barriers and tariffs for non-member countries.

UNILATERAL TRADE AGREEMENT

Definition: agreement that is imposed on one nation by another, and benefits one nation only. Many
smaller, developing nation are afraid of trade agreements involving developed nations because the
imbalance power could result in a unilateral benefit to the developed nation.

Unilateral trade policies occur whenever one country imposes a trade restriction, such as tariff on all
imports. This occurred during the depression as countries sought to protect domestic jobs by raising
import prices through tariffs.

TRADE BLOC

Intergovernmental agreement, where regional barriers to trade are reduced or eliminated among
the participating states.

Regional trading bloc is a group of countries within a geographical region that protect themselves
from imports from non-members.

Form of economic integration, and increasingly shape the pattern of world trade.

Primary objective which is to enable them to take advantage geographical proximity as well as the
enlarged market formed after such mergers.

COMMON MARKETS – type of regional trading bloc

- Having features of a customs unions

- Only free movement of G&S but also labour and capital between its member.
- Labour can move across borders without restrictions.
- May introduce agreement on products. EG, they might standardize product.
- EU is common market.
- A bilateral trade is the exchange of goods between two countries that facilitates trade
and investment by reducing or eliminating tariffs, import quotas, export restraints and
other trade barriers.
- A multilateral trade agreement involves three or more countries who wish to regulate
trade between the nations without discrimination. They are usually intended to lower
trade barriers between participating countries and, as a consequence, increase the degree
of economic integration between the participants.
 Differential Trade Area Lower but not eliminate, barriers among members.

Eliminate internal barriers, but maintain independent external

Free Trade Area barriers.

Custom Union Eliminate internal barriers, agree on common external barriers.

Eliminate internal barriers, adopt common external barriers,

Common Market allow free movement of resources among members.

Eliminate internal barriers, adopt common external barriers, free

Economic Union movement of resources and uniform set of economic policies.

United States
Full integration

What is the TPP?

- Legally binding trade agreement

- The US is driving the agenda to suit its most powerful industries and corporations.
- The TPP contains 29 chapters, and most of these are not actually about trade but about
changing Australian laws and policies to suit US interests.
- 40% of world’s economy
- 25% of global imports
- 11% of world’s population
- 30% of global exports
- 800 million consumers (double EU)

WORLD TRADE ORGANIZATION

- Deals with the global rules of trade between nations. Its main function is to ensure that trade
flows as smoothly, predictably and freely as possible.
- Intergovernmental organization which regulates international trade.
- Functions:
1. Administering WTO trade agreements
2. Forum for trade negotiations
3. Handling trade disputes
4. Monitoring national trade policies
5. Technical assistance and training for developing countries
6. Cooperation with other international organizations

PURPOSE OF WORLD BANK

1. Granting reconstruction loans to war devastated countries

2. Providing loans to governments for agriculture, irrigation, power, transport, water supply,
educations, health etc
3. Promoting foreign investment by guaranteeing loans provided by other organizations
 4. Encouraging industrial development of underdeveloped countries by promoting eco-nomic
reforms.
5. Providing technical, economic and monetary advice to member countries for specific
projects.

ROLE OF INTERNATIONAL MONETARY FUND

- Works to foster global growth and economic stability.

- Provides policy advice and financing to members in economic difficulties.
- Works with developing nations to help them achieve macroeconomic stability and reduce
poverty.
- Mains works:
I. Policy advice to governments and central banks based on analysis of economic trends
and cross-country experiences.
II. Research, statistics, forecast and analysis based on tracking of global regional, and
individual economies and markets.
III. Loans to help countries overcome economic difficulties.
IV. Concessional loans to help fight poverty in developing countries
 THE BALANCE OF PAYMENTS
Definition: Balance of payments is a systematic record of all economic transactions between the
residents of Australia and the residents of the rest of the world.

 It is compiled and reported by the ABS every month.

 Inflow are recorded as credits

 Outflows are recorded as debits.

 Consists of 2 accounts :

o A current account

o A capital and financial account

 Each account is divided into sections with subtotal at the end of each.

DEBIT component of BOP CREDIT component of BOP

 Outflow (payment) of money :
represented by a minus (-ve) sign
 Involves:
i. Imports of goods and services
ii. Country’s investment abroad.
iii. Deposit of money abroad by the
country’s residents.
iv. Various loans to non-residents
made by the country’s bank.
v. Paying bank loans made by the
country’s residents to foreign bank
 Inflows (receipts) of money : is
represented by a positive (+ve) sign
 Involves:
i. Exports of goods and services
ii. Foreign investment in the country
iii. Deposits by non-residents in the
country
iv. Various loans made to the country.
v. Paying back loans made by non-
residents to country’s bank
 THE CURRENT ACCOUNT

Definition: Records all transactions between Australian residents and non-residents

involving goods and services, income and current transfers

Credit Debit
1. Goods: Export (Import)
Rural output, minerals, intermediate,
capital and consumer goods
2. Services: Export (Import)
Transportation, tourism, financial
services, communication, construction
and information
Balance on Goods and Services Export - Import
(BOGS) or Trade balance

LARGEST COMPONENT
OF CAD
 SMALLEST COMPONENT OF CAD

Balance on Goods and Services (Balance on

merchandise trade + Net services)
+
Net Primary Income (Primary income Credit –
Primary income Debit)
+
Net Secondary Income (Secondary Income Credit –
Secondary income debit)
=
BALANCE ON CURRENT ACCOUNT (CAD)
THE CAPITAL ACCOUNT

DEFINITION: Measures transfer in assets and liabilities.

Migrants Funds: Surplus due to net migration.

Capital Formation: Net addition of deduction of fixed capital.

THE FINANCIAL ACCOUNT

DEFINITION: Comprises transactions associated with changes of ownership of Australia’s foreign

financial assets and liabilities.

Balance on Capital Account

+
Balance on Financial Account
=
BALANCE ON CAPITAL & FINANCIAL ACCOUNT (KAS)
The size and movement on BOGS and Net Primary Income are influenced by:

Cyclical Factors: Vary with economic activity. = changes in global demand for commodities

Structural Factors: Persistent influence on BOP = Australia’s export base, international

competitiveness, national savings

1. Cyclical Factors Affecting BOGS

Appreciation of AUD  increase BOGS because higher receipts for Australian exports and
cheaper payments for imports (in the short run). The opposite will occur under a
depreciation
In the LR(Long Run), an appreciation may bring about a fall in BOGS as exports become more
expensive and imports cheaper to pay.
Note: Australia’s mineral exports are demand/price inelastic means any change in price of
these exports may not change the quantity/volume exported in the short run.

a. Exchange rates for AUD

- AUD ↓ (depreciates)  Australia’s export price in terms of foreign currency will ↓, NON-
MINING exports competitiveness will ↑ , import prices will ↑ , discouraging demand for
imports and encouraging X demand  BOGS will increase and CAD (improves)
- When AUD appreciates  Australia’s non - mining international competitiveness will worsen
while encouraging Australians to increase consumption on Imports  BOGS decreases and CAD
worsens/increases.
- Demand for mining exports = PRICE INELASTIC
Change in price of mining exports does not influence the demand to change much, this is as
mining exports are resources which will always be in demand especially from developing
countries as there is no perfect substitute.
- When AUD appreciates, X prices will increase, however demand for mining X will not change
much as demand for mining export is price inelastic, hence X revenue in the mining sector will
increase as will higher price demand is still the same, BOGS will increase and CAD will improve.

b. Terms of trade (TOT)

- TOT  Relationship between the prices Australia receives for its X and the prices it pays for its
imports.
- TOT favorable/improve  Xp > Mp  the same value of X can buy more M, Xrevenue >
Mpayment , BOGS increases, CAD improves/decreases.
- TOT unfavorable/deteriorates  Mp > Xp  Mpayment > Xrevenue, BOGS decreases and CAD
worsens/increases.
- Since 2003 Australia has experienced the largest Terms of trade boom in its history.
- Reason:
o Global commodities boom, Australian exporters have been receiving higher prices for their
exports, increasing export revenue, thus increasing value of Australian exports  this has
improved BOGS, gradually shifting from deficit to surplus.
o At the same time, the rise of China and other low-cost emerging economies has also flooded
world markets with low-cost manufactured goods, reducing import prices and further
increase Australia’s TOT
-
- A higher TOT means that exports receive higher prices for the same output, which increase
export revenue and improves BOGS.
- As TOT increases, it leads to increase in DD for Australian dollar for investment and speculation
purpose in the mining sector - increase in demand for Australian dollar increase the value of
AUD.
- Higher value of AUD weakened the international competitiveness of Australia’s non-
commodity exports
- Commodity export revenue increase , appreciation of AUD also causes non-commodity export
revenue to decrease – this phenomenon is known as ‘Dutch Disease’
- Dutch Disease – growth in one industry results in higher exchange rate and slowly chokes off
other export industries as they lose their international competitiveness

c. Domestic GDP
- An increase in GDP  increase in disposable income  increase in demand for M (large
proportion of M are consumer goods)  BOGS decrease  CAD worsens/increases.
- In 2008-2009 Australia’s GDP dropped due to GFC  spending on M decreased  helped BOGS
move to a surplus

d. Changes in international business cycle

- Strong growth of Australia’s trading partners will increase Demand for Australian export 
BOGS will increase and CAD improves/decreases.
2. STRUCTURAL FACTORS AFFECTING BOGS
a. Australia’s export base
 Australia has a narrow export base  heavily weighted towards primary commodities.
 Australia’s comparative advantage lies in low value added products, such as minerals
and agriculture ( 2/3 of Australia’s export earnings)
 Lacks international competitiveness in manufacturing and tends to import more
expensive high value added product such as consumer goods & capital goods.
 As a result in the long run BOGS tends to be a deficit rather than a surplus  as import
payment > export revenue

b. Volatility of global commodity prices

 Volatility of global commodity prices contributes to large fluctuations in BOGS
 Global commodity boom  significant improvement in Australia’s TOT & ⇑ X
revenue
 Price of manufacturing goods that Australia’s import ⇓  ⇑ Global competition 
low cost production in China

c. Growth of services exports

 Expansion in service export is essential  diversify Australia’s export base and trade
performance
 Employs ¾ of working Australians

d. Capacity of constraints
 Capacity constraints on Australia’s mineral exports due to poor transport
infrastructure & skills shortage
 Poor transport infrastructure, such as low capacity at the national’s port &
inefficient road & tail networks, physically prevents Australian exporters from taking
advantage of favourable cyclical conditions by increase exports volumes
 Shortages of skilled labour ( esp in mining sector) pushes up wages, adding to
business cost and restricting growth in Xs.
 GS has ⇑ on education and training through active labour market programme. (MER)
 1. Cyclical factors affecting primary income account
a. Exchange rate
- Movement in ER will alter the AUD value of debt denominated in foreign currencies = valuation
effect
- AUD appreciates  value of debt denominated in foreign currencies will decrease  decreasing
the value of Australia’s debt service (in AUD terms)  reducing value of net primary income
outflows and improving net primary income deficit  improving CAD.
- Depreciation of AUD will increase the AUD value of debt denominated in foreign currencies 
increasing value of Aust interest repayments and worsening net primary income  deficit
CAD worsens
b. Domestic & global interest rates
- When ⇓ in Australian or global interest rates  as seen in 2008-09 in response to the GFC 
this decrease the value of Australia’s interest repayment obligations and should improve the net
primary income deficit.

c. Domestic business cycle

- When domestic economy experiences strong growth  domestic company profit rise  these
profits are redistributed to shareholders as dividends
- Higher domestic profit  higher equity servicing costs in the form of dividend outflows 
worsening net primary income deficit  CAD worsens

2. Structural factors affecting primary income account

a. Savings and investment gap
 Since domestic savings level is low, Australian producers look to foreign sources of finance to
fund their investment.
 This means Australia tends to fund a large part of its investment through international
borrowing (which increases foreign debt) or selling ownership in Australian assets (which
increases foreign equity)
 This increases Australia’s foreign liabilities and creates future servicing obligations in the form of
interest repayments (on debt) and dividends (on equity)
 These servicing costs are recorded as outflows on the net primary income account, and are the
major causes of Australia’s persistent CAD
 THE CONSEQUENCES OF A HIGH CAD

a. The growth of foreign liabilities

- High Cad  ⇑ level of foreign liabilities
- A CAD assumes financial inflow on capital and financial account (through borrowing from
overseas or through selling equity in items such as property and companies.)
- This means that lenders may become more reluctant to lend to Australia or to invest in Australia

b. Increased servicing cost

- High levels or foreign liabilities leads to larger outflows on the net primary income = worsening
CAD
- Foreign debt must be serviced through interest payments and profits must be returned on
foreign equity investment
- ⇑ of foreign debt  foreign lenders demanding a risk premium on loans, forcing an ↑ of
interest rates

c. Increased volatility for exchange rates

- ⇑ CAD  undermine the confidence of overseas investors in the Australian economy  by
reducing demand for Australian currency, may results in a depreciation of Australian dollar

d. Constraint on future economic growth

- In the long term a high CAD may become a speed limit on economic growth.
- ⇑ of economic growth involve a an increase in imports and ⇓ CAD
- BOP constraints = when economy is limited by the CAD problem

e. More contractionary economic policy

- Government might use tighter macroeconomic policies and accelerate implementation of
Microeconomic reform (MER)- if its is necessary to reduce CAD in short run
- In the short run, tight Monetary and fiscal Policy will reduce economic growth and contribute to
lower CAD

f. A sudden loss of international investor confidence

- High CAD are more vulnerable to shift investors sentiments

Positive Effects / Implication of CAD

1. Sign of strong economic growth  ⇑ living standards  ⇑ DD for M

2. ⇑ level of investment
- Invest for higher return
- Borrowing for investment  Long term economic growth  ⇑ living standard
3. Stronger productive capacity – import of high tech capital equipment  economic growth
4. ⇑ foreign investment  CAD = KAS, natural resources attracts foreign investors  ⇑ rate of
economic growth
 TERMS OF TRADE
 Index which measures the relative movements in the prices of exports
and imports
 Measures the purchasing power of a country’s exports in terms of the
imports it can buy
 The ratio of export prices to import prices and is measured by dividing
an export price index by an import price index multiplies with 100.

 The export price index (XPI) shows the proportional change in the level
of export prices, while the import price index (MPI) shows the
proportional change in the level of import prices.
 Both are XPI and MPI are calculated by selecting a representative group
of exports/imports and determining the weighted average of their
prices.

If TOT < 100  Unfavorable

(TOT deteriorates as compared to the base year)

If TOT y1 > TOT y2  Unfavorable

(TREND - TOT deteriorates as compare to the preceding year)

If TOT > 100  Favorable

(TOT improves as compared to the base year)

If TOT y1 < TOT y2  Favorable

(TREND - TOT improves as compared to the preceding year)

- Improving TOT= ⇑ standard of living, but jeopardized international competitiveness-exports $↑

- Deteriorating TOT= ⇓ standard of living but international competitiveness improves –exports $↓
COMBINATION OF CHANGES IN X & M

An improvement in the terms of trade means that the same volume of exports can buy more imports.

FAVOURABLE MOVEMENT

TOT ⇑

- More imports can be purchased with a given volume of exports OR

- Less exports are required to purchase a given volume of imports
- Purchasing power of national income increases

UNFAVOURABLE MOVEMENT

TOT ⇓

- Less import can be purchased with a given volume of exports

- More exports are required to purchase a given volume of imports
- Purchasing power of national income decreases
FACTORS THAT AFFECT THE TERMS OF TRADE

1. Exchange rate: Fall in ER, reduce TOT. Appreciation in ER, improve TOT
2. Competitiveness of firms: Export $ will be affected by the cost of raw materials and
productivity.
3. Relative inflation rates in different countries: ⇑ Australia’s inflation = deterioration in TOT
4. Profit margins: firms pass the effects of depreciation onto the consumers with higher prices

TERMS OF TRADE AND THE EXCHANGE RATE

- TOT heavily influenced by changes in ER

- ⇑ value of a country domestic currency, ⇓ prices for its import, ⇓ competitiveness of exports
- ⇑ currency, ⇑ TOT, ⇓ balance of trade

EFFECT OF A DEPRECIATION THE TOT

- ⇓ value currency, ⇑ $ import (pay more in AUD for same quantity of foreign goods), domestic
price remain the same (eg. Germans should be able to buy Aussie good for less EURO)

EFFECT OF AN APPRECIATION ON TOT

- Imports cheaper, export will become more competitive, improvement on TOT

SIGNIFICANCE OF CHANGES IN THE TERMS OF TRADE

1. Standard of living = import cheaper goods

2. Prices of imported technology = ↓ TOT, more expensive to import technology
3. Balance of payments = prices of X and M will affect to value of trade flows

TOT & BOP

- Favourable movement in TOT = ↑ export prices rise relative to import prices, → net export
income ↑ → merchandise trade deficit ↓ → CAD ↓
-

FACTORS AFFECTING TERMS OF TRADE

1. Microeconomic changes – change in demand and supply in the market of a specific product
can change the price of export and imports of particular products.

Price elasticity of demand (PED)

a. LOW PED of mining products (inelastic demand)

↑ Export price, quantity does not change a lot → TOT ↑
b. HIGH PED of non-mining products (manufactured and agriculture) (elastic demand)
↑ Export price, ↓ quantity → TOT deteriorate
c. Import of manufactured and capital goods has LOW PED ( inelastic)
↑ Import price, Quantity does not change a lot → TOT deteriorate

Price elasticity of supply (PES)

a. LOW PES of agricultural products (inelastic supply)

→ long production period to produce
When drought/flood occur → ↑ Price of exports → ↑ TOT
Oversupply → ↓ price of exports → TOT deteriorated

Income elasticity of demand

a. Agricultural product exporters

→ any trading partners increase in economic growth → does not lead to sudden increase in
demand → export price does not increase → TOT does not improve
b. Exporter of services such as tourism and education
→ ↑ national income of trading partners → ↑ demand of Australia’s export service → ↑
export price → ↑ TOT
c. ↑ Economic growth increase, ↑ demand for manufactured goods & ↑ imported services, ↑
import price, ↑ TOT
SHORT TERM

• In the short-run, changes in relative prices of imports and exports can be caused by
fluctuations in exchange rates, particularly where countries operate a floating exchange
rate system. Exchange rate volatility may be caused by changes in trade, capital flows,
interest rates, speculation, inflation and use of foreign currency reserves by the
government.

• You will recall that a depreciation of the exchange rate causes import prices to increase
and export prices to decrease, while an appreciation causes the opposite effects.

• Also in the short-run, there may be considerable fluctuation in the prices of commodities
which will affect the terms of trade. This is particularly true for agricultural commodities,
the supply of which is often affected by drought, floods, diseases, etc. Given that the
demand for and supply of these commodities is highly inelastic the change in supply will
cause a proportionately greater change in price.

LONG TERM

In the longer term, changes in the terms of trade are likely to be determined by those factors which
exert a long term influence on the demand for, and supply of, a country's exports and imports.

For countries, who export mainly primary goods and import manufactured goods, their export
prices have tended to fall over time due to a combination of increased supply of and reduced
demand for their exports:

 Supply has increased, mainly due to improvements in technology and new producers
entering the market.

 Demand has fallen / not risen rapidly, for a variety of reasons.

The reasons for demand falling include:

 Development of synthetic substitutes, e.g. plastics have lessened the demand for several
raw materials.

 Low income elasticity of demand for primary commodities - as real world incomes have
grown, the demand for primary commodities has increased less than proportionately.

 Agricultural protection - the developing countries, despite producing at lower cost, have
found it difficult to break into the markets of the richer countries, as farmers there are often
heavily subsidised and, in the case of the European Union, protected by a common external
tariff.

 Miniaturisation - modern microchip technologies have enabled products to become smaller,

e.g. the personal computer, and this has necessitated less use of raw materials and caused
demand to fall.
  Price inelastic demand for exports of primary commodities - compounding the problem of
falling export prices, demand for primary commodities tends to be price inelastic, such that
decreases in prices bring about less than proportionate increases in the quantity demanded.

The above is in sharp contrast to the situation faced by the secondary goods exporting countries -
the export prices of their manufactured goods has risen over time (high income elasticity of demand,
multinational / monopoly control over supply and price) and they have benefited from cheaper
import prices of primary commodities due to the factors described above.
MACROECONOMIC CHANGES WHICH INFLUENCE TOT

a. Relative Inflation Rate

↑ Inflation rate → ↑ export $ → favourable TOT in short run but deteriorates in long run
b. Unemployment rate
↑ UE ↓ economic growth → ↓ export $ → unfavourable TOT in short run but cheaper
exports may increase in demand in the long run then export price increase → TOT
favourable
c. Interest rates
↑ Interest rate ↑ cost of borrowing in export industry → ↑ export $ in short run → TOT
favourable but will deteriorate in long run
d. Relative economic growth rate
↓ economic growth → ↓ export $ → unfavourable TOT in the short run but cheaper exports
may increase in demand in the long run then export price ↑ → TOT favourable

AUSTRALIA TOT

 Little direct influence on M and X price index as they are small consumer of the world
products
 Price of X and M are largely set in the world market.
 Australia is a price taker with respect to the prices of traded goods
 Composition of trade – too reliant on rural and mineral commodities for exports
 Primary products – price inelastic & lower income elasticity of demand
 Commodity price – fluctuates – supply shocks – climatic disaster
EFFECTS OF TERMS OF TRADE

1. TOT affects national income

- Favourable movement of TOT (ceteris paribus) → ↑ national income
- ↑ national income → ↑ standard of living → ↑ import goods → ↑ tax revenue for government
→ ↑ government spending on welfare and infrastructure
2. TOT affects BOGS
- ↑ of TOT  ↑ BOGS surplus
- When XPI improves and demand is price inelastic, export revenue ↑
- When XPI improves and demand is price elastic, export revenue ↓
- In Australia’s case, exports are mainly primary goods (mineral in particular), therefore when TOT
movement is favourable (more imports can be paid with one unit of export, purchasing power of
income increases), ceteris paribus, BOGS improves.
- When MPI improves and demand is price inelastic, import payments ↑
- When MPI improves and demand is price elastic, import payments ↓
- In Australia’s case, imports are mainly capital goods and intermediate goods of which Australia
doesn’t have comparative advantage, therefore when TOT movement is favourable, ceteris
paribus, BOGS improves.

- ↑ terms of trade  ↑Australian exports → ↑ DD for AUD → APP of AUD → ↑ investment

in resources → ↑ GDP [AD=C+I+G+(X-M)] → ↑ national income
 EXCHANGE RATES
Definition: An exchange rate is simply the price of one country’s currency in terms of another
country’s currency. The process by which that price is determined depends on the particular
exchange rate mechanism (floating exchange rate system or fixed exchange rate system.) adopted.

Forex Market: The market in which the currencies of different countries are bought and sold.

RECALL THE BOP

Inflows of funds Outflows of fund
- Exports - Imports
- Income credit - Income debit
- Foreign investment - Australia’s overseas investment
- Capital inflows - Capital outflows
Inflows affects the DEMAND of AUD in the Outflows affect the SUPPLY of AUD in the
FOREX market FOREX market

TWI – TRADE WEIGHTED INDEX

 TWI is a weighted average of a basket of 20 currencies that reflects the importance of the
sum of Australia’s exports and imports of goods by country.
 Often used as one indicator of Australia’s international competitiveness and is a useful gauge
of the value of the Australian dollar when bilateral exchange rates exhibit diverging trends.
 Used to measure the effective value of an exchange rate against a basket of currencies.
 The importance of other currencies depends on the percentage of trade done with that
country.
 A trade weighted index is useful for measuring the overall performance of a currency.
 For example in calculating the trade weighted index of the AUD, the most important
exchange rate would be with the RENMIMBI. If Australia’s exports 30% of total exports to
China, the value of AUD to RENMIMBI would account for 30% of the trade weighted index.
 The interpretation of the effective exchange rate is that if the index rises, the purchasing
power of that currency also rises (the currency strengthened against those of the country's
or area's trading partners). That will reduce the cost of imports but will also reduce the
competitiveness of exports.

EXCHANGE RATE SYSTEMS

- In a floating rate system = the exchange rate is determined directly by market forces and is
liable to fluctuate continually as dictated by changing market conditions.
- In a ‘fixed’ or managed rate system = the authorities (central banks) attempt to regulate the
exchange rate at some level that they consider appropriate. Seems appealing to those who are
troubled by the uncertainties of present, high volatile, floating rate environment.

FIXED EXCHANGE RATE SYSTEM

- Devaluation of currency – government deliberately decrease its value in the forex market
- Revaluation of currency – government deliberately increase the value of the currency in the
forex market
- A fixed exchange rate, pegged exchange rate is a type of exchange rate regime where a
currency value is fixed against either the value of another single currency or a basket of currency
or another measure of value such as gold.
- A country’s exchange rate regime under which the government or central bank (Australia’s
central bank is the Reserve Bank of Australia) ties the official exchange rate to another country’s
currency or to the price of gold.
- The purpose of a fixed exchange rate system is to maintain a country’s currency value within a
very narrow band.

For example if RBA wanted to revalue the

AUD at USD0.60, then RBA would buy
AUD with USD in their reserves. This will
increase the demand for AUD in the
FOREX market thus AUD appreciates

However, if RBA wanted to devalue the AUD

Back to USD0.50, then RBA would sell AUD to
Obtain USD in the FOREX market. This would
Increase the supply of AUD in the FOREX market.
Thus AUD depreciates.

- Provide greater certainty for exporter and importers, which also helps the government maintain
low inflation which in the long run will tend to keep interest rates down and stimulate increased
trade and investment.

FLOATING EXCHANGE RATE SYSTEM

- The price of dollar depends on the relevant forces of supply and demand.
DEFINITION:

 Appreciation of AUD occurs when the value of the exchange rate for AUD increases against
another currency.
 Depreciation of AUD occurs when the value of the exchange rate for AUD decreases against
another currency.

CHANGES IN DEMAND FOR AUD

 When the demand for AUD ⇑ , AUD appreciates, AUD exchange rate value ⇑
 When the demand for AUD ⇓ , AUD depreciates, AUD exchange rate value ⇓

CHANGES IN SUPPLY FOR AUD

 When supply of AUD ⇑ , AUD depreciates, AUD exchange rate value ⇓

 When supply of AUD ⇓ , AUD appreciates, AUD exchange rate value ⇑
EXCHANGE RATES AND THE BOP

The demand and supply of the currency are determined by the international transactions that are
recorded in the balance of payments.

HOW THE FLOWS OF FUNDS IN BOP INFLUENCE THE VALUE OF THE EXCHANGE RATE FOR AUD

INFLOWS OF BOP OUTFLOWS OF BOP

Appreciation of AUD Appreciation of AUD
- ⇑ in inflows of funds into Australia  ⇑ the - ⇓ in outflows of funds out of Australia 
demand for AUD ⇓ the demand for AUD
Depreciation of AUD Depreciation of AUD
- ⇓ in inflows of funds into Australia  ⇓ the - ⇑ in outflows of funds out of Australia  ⇑
demand for AUD the demand for AUD
FACTORS AFFECTING THE DEMAND FOR AUSTRALIAN DOLLARS

1. The demand for Australian exports

When Australian G&S are bought by overseas consumers, they need convert their currency
into AUD to pay the exporters.  ↑ Demand for Australian exports → ↑ value of AUD
2. Taste and preferences of overseas consumers for Australian exports
Same as above.
3. Growth in global economic conditions.
↑ World economic growth → ↑ demand for G&S → ↑ AUD
4. International competitiveness
To be competitive in the global market, the G&S must be cheap.
If inflation rates and cost ↑ than overseas competitors  G&S will be expensive  ↓
export market  ↓ demand for AUD = Depreciation
5. Capital inflow
Interest rates are relatively higher than overseas interest rates  ↑ capital flow (foreign
investors)  ↑ demand for AUD
6. The expectation of higher levels of domestic economic growth
This will also influence size of capital inflow and ↑ demand for AUD → appreciation
↓ Capital inflow  ↓ demand for AUD  depreciation
7. Speculation
If foreign investors expect the value of the Australian dollars to increase in the future → they
may sell other currencies and buy Australian dollars  demand for AUD → appreciates

FACTORS AFFECTING THE SUPPLY FOR AUSTRALIAN DOLLARS

1.