Unit 3 AOS 3
Relationship between trade and living standards
Lower prices for consumers - creates a more competitive market by increase the number of sellers and thus competition on price
Greater choice for consumers - greater variety of g/s to purchase as Australia could never produce all the different types of products produced in the global market
Firms have better access to resources - by operating in a global market Australian firms have a greater access to resources at a lower cost which can be passed on as lower prices
Firms achieve economies of scale - the more that is produced (due to a larger market for consumption) firms have a greater ability to spread fixed costs over a larger output and thus reduce average costs per unit
Balance of payments
Records financial transactions between Australians and residents of the rest of the world
Money coming in = credit
Money going out = debit
Current account (payments that do not result in future obligations)
Capital and financial account (payments that result in future obligations)
Balance of merchandise trade/net goods - receipts for exports of goods minus payments for imports of goods
Capital account - net flows of assets of migrants and net flows from transfers of intellectual property
Net services - exports of services less imports of services
Net primary income - income from holding foreign assets minus payments of income to service foreign liabilities e.g. loan repayments/dividends
Net secondary income - payments to and from Australia where nothing is expected in return
Financial account
Net direct investment - value of Australian direct investments in foreign countries minus foreign direct investments in Australia e.g. starting a business or buying land
Net portfolio investment - value of Australian portfolio investments in foreign countries minus foreign portfolio investments in Australia e.g. shares
Financial derivatives - value of the net position of complex financial instruments
Net other investments - value of net position on other investments e.g. loans
Net reserve assets - value of the net position of payments to and from the RBA and the Australian government
Relationship between the CAD and CAFA - if Australia runs a CAD, money must be borrowed in order to finance this debt which increases CAFA therefore Australia must run a CAFA surplus in the same period
CAD, NFD and NFE
CAD
Structural reasons for CADs
Savings and investment imbalance - combination of low savings and many investment opportunities means that there is insufficient funds in Australia to fund the level of investments which would maximise growth and so funds are sought from overseas
Low levels of international competitiveness - largely due to highest minimum wage in the world, makes it difficult for our exports to compete in the global market and makes imports more attractive to Australia buyers
Self-reinforcing nature of the CAD - each year Australia runs a CAD funds must be borrowed in order to finance it meaning in subsequent years interest must be paid and this is a debit on the net primary income component
Cyclical component - when growth is strong CAD tends to be lower and vice versa
NFD
The amount by which Australia's borrowing from overseas exceeds Australia's lending overseas
Australia has a large NFD (60% GDP) with 80% being private debt
Reasons to worry about NFD - can default on debt, too big of an NFD would down grade Australia's credit rating which would result in higher interest payments, more national income is devoted to paying off the debt
Reasons not to worry about NFD - most of it is private borrowing, there has been an improvement in current times, if GDP is growing at a fast enough rate to afford the level of NFD then it is okay
Terms of trade
Index which measures the ratio of average prices for Australian exports to the average prices for Australian imports
Export price index/import price index x 100
Impact on living standards - increase in the terms of trade tends to increase living standards as if export prices rises, Australian exporters receive more profits which can be passed on as increasing in wages, investment and dividends, if import prices drop this reduces the costs of imported capital and intermediate goods which can be passed on as a decrease in selling prices
SSEG and full employment - a higher ToT will raise consumption and investment, increase AD and real GDP
Low inflation - higher ToT caused by decreases in import prices will reduce inflationary pressures as it reduces the risk of cost inflation as the costs of imported capital and intermediate goods decreases BUT if caused by increases in export prices this can increase inflationary pressures as it increase demand inflation (increased net exports)
CAD - higher ToT will reduce the CAD as increases in export prices or decreases in import prices will increase the trade balance
Exchange rates
Measured in USD or the trade weighted index which is an index based on the currencies of our major trading partners weighted based on how much we trade with them
Appreciation means that the value has increased caused by either an increase in demand or decrease in supply of the AUD
Depreciation means the value has decreased caused by either a decrease in demand or an increase in supply of the AUD
Factors affecting the value of the exchange rate
Relative interest rates - when interest rates in Australia are higher than interest rates in other countries this attracts investment to Australia = increased demand for AUS as to lend money in Aus you need to convert to AUD) = appreciation
Terms of trade - when ToT increases there will be an increase in the demand for AUD as more AUD is required to purchase exports and less supply of AUD as Australian firms require less AUD to purchase imports = appreciation
Relative rates of inflation - if Australian inflation rates are higher than our competitors this will make exports less competitive and import computing businesses less competitive = depreciation
Impact on SSEG - they act as an automatic stabiliser, increasing or decreasing growth when the opposite is occurring to ensure growth is not excessive e.g. when growth is strong = appreciation = decreases demand for exports = decreases growth
Full employment - similar stabilising effect, when unemployment is high because growth is low the AUD will depreciate and tend to increase employment
Living standards - increases MLS if growth increases and logical links to NMLS
Low inflation - appreciation of AUD = reduction in inflationary pressures as on the demand side it reduces net exports and thus demand inflation and on the supply side it makes imported inputs cheaper and thus reduces cost inflation
CAD - appreciation of AUD = increases CAD as exports are more expensive and imports are cheaper = reduce surplus or increase deficit of trade balance
International competitiveness
How well Australia competes in the global market based on prices and quality
Factors affecting international competitiveness
Productivity - increases in productivity increase IC as production costs can fall and thus countries can firms better on prices
Costs of production - influenced by productivity, labour costs, capital etc., affects firms ability to compete on price
Natural resources - Australia has an abundance of natural resources, means increased inputs for production
Exchange rates - acts as an automatic stabiliser, if Australia is less competitive there is less demand for AUD and more demand for imports = decreasing demand and increasing supply fo AUD = depreciation of AUD = increases competitiveness
Relative inflation rates - low relative inflation rate = increases competitiveness as our exports and import competing businesses are competing better on price
SSEG - increased competitiveness especially if caused by productivity growth
Full employment - increased competitiveness means that suppliers can increase productive capacity and thus their demand for labour
Low inflation - reduces cost inflation as have greater outputs to share fixed costs across and decreases cost inflation and helps to increase AS so reducing risk of demand inflation
Living standards - logical links
Trade liberalisation
Pursuing government policies that promote free trade between countries such as reduction in tariffs, removals of import quotas
Impact on international competitiveness - forces Australian firms to compete in the global market and thus increase technical efficiency so they can compete better on price, encourages them to focus on areas of comparative advantage, reduces costs of imported inputs
SSEG - helps to achieve as it encourages technical and allocative efficiency thus increasing AS and reducing the costs of imported inputs = increases AD
Full employment - helps to achieve as it encourages growth and thus the derived demand for labour BUT may increase structural unemployment in the short term as firms are outcompeted and shut down
Low inflation - helps to increase AS and thus reduce the risk of demand inflation and reduces the costs of imported inputs and reduces CPI directly decreasing cost inflation