UNIT 3 AOS 3

• Gains from international trade

  • Increases access to resources, enabling higher production and living standards
  • Increases specialisation, competition and efficiency, and living standards
  • Promotes greater economies of scale production and living standards
  • Boosts GDP, jobs, incomes, and living standards
  • Increases consumer choice and living standards
  • Keeps consumer prices lower, improving living standards
• Disadvantages of international trade

  • Benefits have not been shared equally between nations + individuals
  • Rise in structural unemployment associated with foreign competition leading to local business closures, as less efficient firms struggle to compete
  • Trade and specialisation have increased our global interdependence, but has also made countries more vulnerable to disruptions to international supply chains caused by global shocks
  • Environmental costs: of increased trade associated with increased from transportation of goods, as well as costs from the over exploitation of common access + non-renewable resources
• Balance of Payments (BOP)

  A statistical record of financial transactions between Australia and the rest of the world
• Accounting system of BOP


  Credits are money received by residents, debits are money paid overseas
• BOP always balances because every dollar spent abroad by Australia is matched by a dollar earned from abroad
• Components of the Current Account

  • Net goods: difference between export credit and import debits
  • Net services: difference between service credits and service debits
  • Net primary incomes: difference between income credits (wages, dividends), and income debits (interest, profits)
  • Net secondary incomes: difference between secondary income credits (pensions) and debits (gifts, taxes)
• Current Account Deficit (CAD)

  Debits exceed credits over a period
• Current Account Surplus (CAS)

  Credits exceed debits over a period
• Components of the Capital and Financial Account

  • Capital account: records net capital transfers and acquisition/disposal on non-produced non-financial assets
  • Financial account: the total value of credits for investments and lending by Australians abroad minus the total value of debits for investments and lending by Australians abroad
• Components of the Financial Account

  • Net direct investment: inflows from foreign investment in Australia minus Australia investment abroad
  • Net portfolio investment: difference in transactions of foreign and Australia shares, debit, and securities
  • Net financial derivatives: value of financial contracts credits minus debits
  • Net reverse assets: RBA and government dealings in foreign currencies, gold, and IMF contributions
• Net errors and omissions

  Reflect inaccuracies in BOP calculations
• Cyclical (demand) influences on the current account balance

  • Domestic conditions: stronger local spending weakens the current account, weaker spending strengthens it
  • Overseas conditions: stronger foreign demand strengthens the current account, weaker demand weakens it
  • Economic activity pickup: boosted exports to China and USA during 2020-1
  • Border lockdowns: reduced imports of services and spending abroad during COVID-19
  • Exchange rate: lower AUD strengthened export competitiveness
  • Lower consumer and business optimism and reduced disposable income has slowed spending and encouraged higher levels of domestic savings
• Structural (supply) influences on the current account balance

  • Production costs: rising costs weaken the current account, lower costs strengthen it
  • National savings gap: high overseas debt from savings, investment gap weakens the current account
  • Rising oil prices: huge rises in oil prices in 2022-23 increased import debits, weakening the current account balance
  • Overseas debt: high levels of overseas debt due to the national savings, investment gap weakened the structural component of the current account balance
  • Slow rises in real unit labour costs have helped keep production costs and lower prices lower, strengthening our international competitiveness
  • Australia has experienced a number of severe climatic events over the last few years, damaging infrastructure, destroyed businesses, and reduced export capacity
  • A weak growth in labour productivity averaging -0.1% a year over the two years to 2020-1, has tended to undermine Australia's international competitiveness
• Net international investment position

  Measures Australia's net international financial obligations, comprising net foreign liabilities (NFL)
• Net foreign debt (NFD)

  Represents total borrowing from foreign lenders minus lending to foreign borrowers
• Net foreign equity (NFE)

  Measures net equity obligations from foreign ownership of Australia assets and Australia ownership of foreign assets
• Factors contributing to Australia's large NFL and NFD

  • Australia's national spending exceeding national income and insufficient national savings to support investment
  • From 2019-23, current account surpluses lead to a net inflow of funds, reducing NFL's as Australia entities purchasing more foreign financial assets
  • Public sector borrowing: government borrows from overseas to finance budget deficits→↑NFD
  • Federal debt: between 2008-09, 2022-23, Australia accumulated over $660 billion in debt due to budget deficits, with public sector debt comprising 30% of the total NFD by 2022-23
  • Private sector borrowing: includes companies and banks, accounting for around 70% of Australia overseas borrowing
• Reasons for private sector borrowing

  • Companies borrow to finance business expansion
  • Banks borrow due to high domestic interest rates and insufficient national savings
• Causes of Australia's NFD

  • Lack of domestic savings: Australia now reliant on borrowing, contributing to high NFD and interest rates
  • Budget deficits
  • Foreign investment opportunities: Australia natural resources attract foreign investment→increased economic productive capacity and external liabilities
  • Lower value of the AUD: lower = purchases of our assets cheaper
• Benefits of foreign debt

  • Finance for future expansion: enhances productive capacity, GDP, employment opportunities
  • Access to cheaper credit: FD provides access to lower interest rates, reducing production costs
• Costs of foreign debt

  • Economic hardship: higher taxes, reduced government spending, economic contraction
  • Burden of debt repayment for future generations
  • Australia may lose its AAA credit rating resulting in higher borrowing costs
  • Interest repayments abroad weaken our current account balance
• Terms of Trade (TOT)


  Measures the ratio of the average price the world pays Australian exports against the average price Australia pays for imports
• Favourable TOT


  When export prices rise faster or fall slower than import prices
• Unfavourable TOT


  When export rise slower or fall faster than import prices
• Measurement of TOT

  Export price index/import price index x 100
• Factors affecting Australia's TOT

  • Changes in global conditions of demand
  • Economic growth rates among trading partners→more growth overseas leads to increased demand for exports
  • Consumer and business confidence levels abroad
  • Changes in disposable income or population
  • Domestic inflation rates and international competitiveness→demand decreases when prices for Australia exports are inflating at a faster rate than elsewhere
  • Changes in global supply: Discoveries overseas increase what we export, Technological advances increased our exports, Ideal growing conditions for crops increase exports, Production costs and profitability globally increases exports, Supply disruptions in key countries affects global prices and TOT
• Impact of exchange rate on TOT


  Depreciating exchange rates can either increase or decrease TOT depending on currency denominators of exports and imports
• TOT impact on current account balance

  • A fall in TOT = lower export prices relative to import prices, decreasing the current account balance, by increasing CAD or decreasing CAS as the value of imports outweighs exports
  • A rise in TOT = higher export prices relative to import prices, strengthening the current account balance by reducing CAD or increasing the CAS
• TOT impact on macroeconomic goals

  • Economic growth: rise in TOT increases value of export sales, boosting injections and strengthening AD. A fall however leads to reduced production, hindering EG
  • Unemployment: fall in TOT=reduced production, leading to decreased to decreased demand for labour, increasing cyclical unemployment. A rise = opposite
  • Inflation: fall in TOT = reduces AD and pressure on prices, slowing demand inflation. A rise = initially inflation may remain stable due to unused capacity, over time increased demand may slowly push up inflation
• TOT impacts on living standards

  • A fall in TOT: reduces national income, decreasing average incomes and purchasing power. Leading to reduced consumption + weaker economic growth. Higher unemployment = increased stress, unhappiness, and social isolation
  • A rise in the TOT: raises incomes = enhancing material living standards. Lower unemployment = opposite
• Exchange rate


  Measures the price or value of the Australian dollar when it is swapped for other currencies
• Trade Weighted Index (TWI)

  The averaged value of the AUD compared to weighted basket of foreign currencies of Australia's trading partners
• Floating exchange rate


  The equilibrium price for the Australian dollar is decided in the foreign exchange market by currency buyers and currency sellers
• Demand for the Australian dollar

  • Paying for Australia exports
  • Paying primary income to Australians who own overseas assets
  • Money transfers from foreign countries to Australia (secondary income)
  • Foreigners investing directly or through portfolio investment in Australia
  • Foreigners lending money to Australians
• Depreciation


  AUD buys less foreign currency, caused by decreased demand or increased supply of AUD
• Appreciation


  AUD buys more foreign currency, caused by increased demand or decreased supply of AUD
• Factors affecting the exchange rate

  • Relative interest rate and capital flows
  • Terms of trade (TOT)
  • Currency speculation and credit rating
  • Relative rates of inflation
  • Demand for and supply of exports and imports
• The exchange rate as an automatic stabiliser


  • Appreciates during strong economic activity, reducing export growth, stimulating imports, and containing AD and GDP
  • Depreciates during weak economic activity, increasing export competitiveness, stimulating AD and GDP
• Demand side effects of exchange rate changes

  • Increased price competitiveness for non-price taker exporters
  • Higher relative price competitiveness for import competing businesses
  • Overall, net exports increase, boosting AD and economic growth
• Supply side effects of exchange rate changes

  • Higher costs for imported inputs and capital goods
  • Increased production costs, potentially reducing AD and economic growth