AOS3: Australia and the international economy

Question 1

KKP1:
Identify the benefits of international trade

Answer 1

1: Access to resources
2: Economies of scale
3: Lower prices for consumers
4: Increased competition and efficiency
5: Greater choice

Question 2

KKP1:
Explain how international trade yields benefit 1: and make a linkage to living standards.

Answer 2

International trade increases the number of resources Australian firms can access to aid production, helping improve the aggregate supply of the nation as whole. This leads to higher production volumes and thus more goods and services available for consumers to purchase, improving material living standards in the economy.

This can also improve non-material living standards as well, given higher production volumes create a higher demand for labour, which often improves people’s social connections and aids a better quality of life, improving non-material living standards.

Question 3

KKP1:
Explain how international trade yields benefit 2: and make a linkage to living standards.

Answer 3

International trade allows Australian firms to have access to a much larger market, meaning firms are generally able to generate a higher sales volume. In turn, fixed production costs are distributed across a greater sales volume as well, reducing the cost per unit sold and improving firm’s profitability. In turn, firms have the willingness and ability to expand national production.

This creates a greater demand for labour, increasing employment and average incomes, meaning people have access to more goods and services and see improved material living standards. Higher employment can also improve social connections and create a higher life quality, improving non-material living standards as well.

Question 4

KKP1:
Explain how international trade yields benefit 3: and make a linkage to living standards.

Answer 4

International trade exposes Australian firms to foreign competition, meaning for domestic firms to compete they must lower prices and maintain them low (otherwise, consumers will purchase everything from overseas). This lowers inflation and ensures the cost of living isn’t too high in the economy.

Thus, consumers can access more goods and services, improving material living standards. Lower prices can also lower people’s stress levels, improving their quality of life and aiding non-material living standards as well.

Question 5

KKP1:
Explain how international trade yields benefit 4: and make a linkage to living standards.

Answer 5

International trade exposes Australian firms to foreign competition, meaning firms must employ the best resource usage when producing goods and services, as this’ll allow them to compete with foreign producers.

Productive efficiency: To compete with international firms, prices must decrease. In order for firms to do this without harming profitability, they must produce as much as possible at the lowest cost, which promotes productive efficiency in the economy.

Allocative efficiency: To compete with international firms, Australian producers must ensure they produce goods and services of a high enough quality to meet the needs and wants of consumers, promoting allocative efficiency.

Dynamic efficency: To compete with international firms, Australian producers must also keep their resources mobile so that they can respond to sudden shifts of demand from consumers.

Question 6

KKP1:
Explain how international trade yields benefit 5: and make a linkage to living standards.

Answer 6

International trade provides consumers with a wider range of goods and services to consume, thus giving them a greater choice. This improves their accessibility to different kinds of goods and services that can meet their needs and wants, improving material living standards. Many of these goods and services include technological goods, which allow people to connect with others better and have a greater quality of life, improving non-material living standards.

Question 7

KKP2:
Define the “Balance of payments.”

Answer 7

The balance of payments is a record of all the transactions that occur between Australia and the rest of the world over a given period of time.

Question 8

KKP2:
Describe the kinds of transactions recorded in the Current account and list its sub-accounts

Answer 8

The current account records all transactions that occur in the short term and have no future obligation, including transactions of goods, services, and income.

Net goods: (Balance of merchandise Trade)
Net services:
Net primary income:
Net secondary income:

Question 9

KKP2:
What yields a debit and a credit entry under the Net primary income account

Answer 9

When money/income enters Australia due to the ownership of a foreign asset, a credit entry is created in the Net-primary income account.

When money/income leaves Australia to finance a foreign debt, a debit entry is created under the Net-primary income account.

Question 10

KKP2:
What yields a debit and a credit entry under the Net secondary income account

Answer 10

One way transfers of money/income are recorded in the Net-secondary income account. For instance, if an Australian received a donation from someone overseas a credit entry will be created in the Net-secondary income account. However, if Australia provides foreign aid to another nation, then a debit entry is created under the Net-secondary income account.

Question 11

KKP2/3:
Explain how “cyclical factors,” affect the Current account

Answer 11

Any AD factor (increasing or decreasing AD in the economy) will impact import spending by Australians and thus debits under the current account, specifically under the Net goods and Net service accounts.

Any AD factor (increasing or decreasing AD in another economy) in a trading partner will impact spending on Australian exports and thus credits under the current account, specifically under the Net goods and Net service accounts.

Question 12

KKP2/3:
Describe how “Structural factors,” impact the Current account

Answer 12

Any factor impacting the AS of the economy will affects firms and their willingness/ability to produce goods and services, impacting the volume of exports by the economy and the value of credits under the Current account (specifically the Net Goods and Net Services accounts).

Question 13

KKP2/3:
Explain how the “Savings and Investment gap,” has impacted and continues to impact the Current account

Answer 13

The Australian economy does not have enough savings to fund its investments, meaning that economic agents in both the public and private sectors have relied heavily on overseas borrowing to fund their domestic investments for many years. Thus, the nation has large amounts of debt and pays high interest payments in interest, resulting in a high value of debts under the net primary income account. This is a historical reason why Australia is usually in a current account deficit.

Question 14

KKP2:
Describe the types of transactions recorded in the Capital account

Answer 14

Transactions that involve capital transfers and transfers of non-financial/non-produced assets.

Non-produced assets: Land resources (Were not created via production)
Non-financial assets: Assets that don’t represent claims against other entities. Owning a building.

Question 15

KKP2:
Describe the different categories of the Financial account and the types of transaction recorded in each.

Answer 15

This account records all transactions involving investments or borrowing received by Australia (credits) and transactions involving investments and borrowing going to other economies by Australian economic agents.

Net-direct investment: Transactions that result in a change in the controlling interest of an Asset. For instance, purchases/set ups of companies, expansion of companies, as well as other kinds of assets.

Net portfolio investment: Transactions that don’t result in a change in the controlling interest of an asset. For instance, buying shares, government bonds and other similar kinds of investments.

Question 16

KKP4:
Define the term “Net foreign debt.”

Answer 16

The total stock value of loans owed by Australia to the rest of the world, less the total stock value of loans owed by the rest of the world to the Australian economy.

Question 17

KKP4:
Define the term “Net foreign equity.”

Answer 17

The total stock value of Australian assets owned by foreign investors, less the total stock value of foreign assets owned by Australians (across different nations in the world).

Question 18

KKP4:
Define the term “Net foreign Liabilities.”

Answer 18

This describes the financial position of the Australian economy at a given point in time, and is found via the sum of the NFD’s and NFE’s of the nation.

Question 19

KKP4:
Outline the causes of NFD trends

Answer 19

1: Savings and investment gap
As Australia hasn’t got sufficient savings to fund its investments, the economy has historically relied immensely on burrowing from overseas to fund domestic investments. This has contributed to really high levels of Net foreign debt overtime.
2: Budget deficits
Whenever a budget deficit occurs, (government spending exceeds government earnings) the public sector looks to overseas burrowing to finance this situation, increasing Net foreign debt.
3: Relatively high interest rates in Australia
This often incentives economic agents in both the public and private sector to burrow overseas as a cheaper alternative when domestic interest rates are high, increasing Net foreign debt.

Question 20

KKP4:
Outline the causes of NFE trends

Answer 20

In Australia, 10% of workers’ wages must go into a ‘Superannuation fund,’ and the total pool of superannuation funds in the economy continually grows each year. Often, a fair amount of this money from worker’s wages is eventually invested into foreign assets, contributing to a highly negative value of NFE in Australia.

Question 21

KKP4:
Outline the relationship between the Current account and Net foreign liabilities

Answer 21

If there is a current account surplus, the excess funds can be used to pay off foreign loans (reducing Net foreign debts) or to invest higher volumes overseas in foreign assets (reducing Net foreign equities). Ultimately, this will decrease Net foreign liabilities in Australia.

If there is a current account deficit, the lack of funds can result in less overseas investment by Australians (increasing Net foreign equities) or more burrowing from overseas (increasing Net foreign debts). Ultimately, this will increase Net foreign liabilities in Australia.

Question 22

KKP5:
Define the “Exchange rate.”

Answer 22

This is the value of one nation’s currency when swapped or traded for another nation’s currency. So, how much can one currency can one purchase of another currency?

The Australian exchange rate is known as the AUD and is determined by comparing the currency to a basket of other currencies (this can also be referred to as the trade-weighted index).

Question 23

KKP5:
Explain what an “appreciation,” of the exchange rate means and when it occurs

Answer 23

This is when the value of the AUD goes up (meaning one Australian dollar can afford more of another currency, and one dollar of another currency can afford less of the AUD).

This occurs when there is an increase in the demand for the AUD (more people buy it on the foreign exchange market) or when there is a reduction in the supply of the AUD (fewer Australians are buying other currencies).

Question 24

KKP5:
Explain what a “depreciation,” of the exchange rate means and when it occurs

Answer 24

This is when the value of the AUD goes down on the foreign exchange market. In essence, this means that one Australian dollar can buy less of another currency, or one dollar in another currency can buy more of the Australian currency.

This occurs when the demand of the AUD goes down on the foreign exchange market (fewer people are trying to purchase it), or when the supply of the AUD goes up on the foreign exchange market (more Australians are trying to purchase other currencies with the AUD).

Question 25

KKP5: List and explain the factors affecting the AUD

Answer 25

Relative interest rates: If interest rates are relatively high in the Australian economy, this means foreign investors will earn a greater return when investing in Australian banks, increasing their willingness to purchase the AUD on the foreign exchange market to make an investment, causing more demand for the AUD and an appreciation. Relative inflation rates: If Inflation rates are relatively high in the Australian nation, this creates a risky environment for foreign economic agents to make investments, as following inflation there is the contraction phase of the business cycle, where consumption falls and the value of certain investments can possibly drop as well. This also means the prices of goods and services will be high, reducing demand for Australian exports and the AUD on the foreign exchange market, causing a depreciation. Commodity prices: Australia is a major exporter in the global commodity market, meaning price variations of these products will affect the value of Australian exports. So, a rise in commodity prices will mean foreign nations will be required to purchase a higher volume of the AUD to access the same level of exports, increasing demand for the AUD on the foreign exchange market and causing an appreciation. Credit rating: If an economy has a higher credit rating, it means they are more likely to pay off its debt and interest owed to other nations. This will increase foreign agents' willingness to invest in Australia, increasing the demand for the AUD on the foreign exchange market, causing an appreciation of the AUD. Demand for exports and imports: If the demand for Australian exports rose, the demand for the AUD on the foreign exchange market would also rise as a this is required to purchase more exports. In turn, there would be an appreciation of the AUD. Vice versa if the demand for exports were to decrease. If the demand for imports into Australia rose, then the supply of the AUD to the foreign exchange market would also increase as this is required to buy more imports, causing a depreciation of the AUD. Vice versa, if there is a reduction in the demand for imports. Terms of Trade: If the Terms of trade rises (positive trend), the exchange rate will appreciate. This is because rising export prices or lowering import prices will both yield an appreciation of the AUD. If the Terms of Trade declines, then there will be a depreciation of the AUD. Foreign investment: For what ever reason, if there was to be an increase in the level of foreign investment within Australia, then the demand for the AUD on the foreign exchange market would increase, causing an appreciation of the AUD. If the levels of overseas investment by Australians were to increase, then the supply of the AUD on the foreign exchange market would rise, causing a depreciation of the AUD. Speculation: If certain speculators anticipate that the AUD will rise in value then there will be a short term rise in the demand for the AUD on the foreign exchange market, causing an appreciation of the AUD. As if these foreign economic agents purchase the currency at a lower price than its upcoming appreciated price they can earn a profit.

Question 26

KKP5: Explain how an increasing exchange rate will affect living standards and the domestic macroeconomic goals.

Answer 26

Goal 1: An increasing value of the AUD will make Australian exports more expensive for foreign consumers and less attractive, leading to less export spending, lowering net exports and GDP growth as a whole. (Import spending will rise, leading to lower GDP growth as well) Thus, this trend will harm the strong component (leading to insufficient levels of employment) of this goal but aid in achieving the sustainable component of this goal (as lower growth can help ease environmental degradation, external and inflationary pressures). Goal 2: As GDP growth will decrease if the exchange rate rises in value (lower net exports), national levels of production and labour demand will fall as well. This will cause an increasing unemployment trend in the economy, harming the achievement of this goal if the rate is above 4.25% or aiding in the achievement of this goal if the rate is below 4.25%. Goal 3: As GDP declines when the exchange rate rises, this means the total spending and demand for goods and services falls as well. This will lower demand inflation in the economy, causing a decreasing inflation trend as a whole. So, if inflation is above the target of 2-3%, then this will aid in achieving the goal, but if inflation is below the target, then the achievement of this goal will be harmed. Material living standards: A rising exchange rate will cause a lower net exports value and less GDP growth. There will hence be less production and fewer goods and services available for consumers to purchase, eroding material living standards. Due to less production, labour demand will fall and unemployment will rise, reducing average incomes and hence ability for people to purchase goods and services, also eroding material living standards. Non-material living standards: Higher levels of unemployment can lead to certain people's social connections becoming non-existent, perpetuating isolation and depression and eroding people's life quality in non-monetary terms, harming non-material living standards.

Question 27

KKP6: Define the "Terms of Trade."

Answer 27

This is a ratio comparing the average Australian export prices to import prices.

Question 28

KKP6: Identify and explain the factors affecting the Terms of Trade in Australia

Answer 28

Global commodity prices: Australia is a major exporter in the global commodity market, meaning global price trends in commodities will impact the average export prices received by the Australian economy. Overseas production costs: Costs of production in overseas firms dictate the prices they charge foreign consumers (including those in Australia) for their goods and services. This directly affects the import prices for Australian consumers and the overall trend in Australia's terms of trade.

Question 29

KKP7: Define the term "International competitiveness."

Answer 29

Australia's ability to compete in international markets on both price and quality.

Question 30

KKP7: List the factors affecting international competitiveness and explain them.

Answer 30

Production costs: If production costs increase (less favorable AS conditions) domestically in Australia (including items like wages) then firms must raise their prices to protect profits, resulting in higher (and less attractive) prices for Australian exports on the international market. This erodes the economy's international competitiveness. Accessibility of natural resources: Australia is quite rich in natural resources such as minerals, Productivity: Exchange rates: Relative inflation rates: