Chapter 4 Terms of Trade Flashcards
(25 cards)
What is the terms of trade
The terms of trade is an index which measures the relative movements in the price of exports and imports.
Why is TOT Important
The ToT can be used as an economic measure of our prosperity
It reflects the capacity of a given quantity of exports to pay for a quantity of imports.
Formula of terms of trade
(πΈπ₯ππππ‘ πππππ πΌππππ₯ (πππΌ))/(πΌπππππ‘ πππππ πΌππππ₯ (πππΌ) ) π₯100
2 reasons why TOT will rise
Export prices rise (fall) or
Import prices fall (rise)
WHat is fall in TOT called
unfavourable movement.
What is rise in TOT called
Favourable movement
What will an increase in TOT mean
βMore imports can be purchased from a given volume of exportsβ
Factors affecting TOT commodity prices explanation
Changes xpi and mpi index affect TOT
Aus is known as price taker for export prices - price of commodities is set by demand and supply of world market
Aus exports mainly commodities - mining and agriculture
As demand, therefore price of commodities increase do does XPI
Same time Aus imports domianted by manufacuted goods
increase in cost of production of these goods willl increase MPI and reduce TOT
Oil prices spiked in 2022 during Russia war, increasing petrol prices increasing MPI
Increase tech over time will reduce production costs especially technology goods, which will reduce MPI over time
Factors affecting terms of trade exchange rate
A change in the exchange rate can also be the cause of a change in the terms of trade
For example:
A depreciation in the exchange rate will increase the price of imports in AUD terms. This will then increase our MPI.
Example:
At the same time, a depreciation of the AUD can impact on our export prices.
A depreciating exchange rate will mean that demand for our commodities increase as it is now cheaper in foreign currency, which would also increase the price of our exports and our XPI.
Therefore a depreciating AUD, will increase the XPI, but also increase the MPI.
The final result for our terms of trade will depend on the relative increase of the XPI vs the MPI.
If XPI increases more than MPI, the ToT improves. If MPI increases more than XPI, the ToT worsens.
How volatile is XPI compared to MPI and the reason
The MPI is less volatile compared to the XPI (Especially when you remove the outlier of COVID-19)
The XPI is about twice as volatile than the MPI over the 10 year range.
The reason is the that supply of manufactured goods (our imports) is quite elastic
This means that for manufactured goods when demand increases/decreases there will be a smaller effect on price.
TOT trends 2016-2019
2016-2019:
World economic growth increases, saw an increase in demand for commodities and therefore saw our XPI increase.
XPI increased 40% in this time, and the ToT increased by 30% as there was a slight increase in MPI.
TOT TRENDS IN 2020
COVID-19 saw a global recession. XPI and MPI fell
TOT TRENDS IN 2021
Recovery of economies saw a surge in demand for commodities. This had a large effect on the XPI and TOT
TOT TRENDS IN 2022
War in Ukraine/Russia saw energy prices spike (LNG, coal, gas etc).
This increase in prices of our exports meant that ToT reached record highs.
TOT TRENDS IN 2022 - 2024
After reaching high levels in 2022, iron ore prices declined, as Chinaβs economic recovery was weaker than expected.
Countries focused on controlling inflation, rather than boosting infrastructure spending. This sharply reduced the XPI.
As inflation gradually fell, so too did many production costs of imports.
This slightly lowered the MPI.
What are many things change in TOT can affect
The Business Cycle
Output, Employment and Inflation
National income
Standard of Living
Government Tax revenue
The Trade Balance/Current Account Balance of the BoP
The exchange rate
Effects of changes in TOT on trade balance
Australiaβs ToT affects the trade balance in Australiaβs BoP.
The ToT measures the price of exports and imports
The trade balance measures the value (price x quantity sold) of exports and imports.
Generally, the ToT and the balance of goods and services has a positive relationship. A rise in export prices, increases the value of exports
For example in 2022, Australia recorded its highest trade surplus, as a result of record high terms of trade.
When export prices (XPI) increases we will see an increase in export values.
When import prices (MPI) decrease will see a decrease in import values.
Both of these movements will cause an increase in the Terms of Trade, and an increase in the Trade Balance. The opposite will occur when we see a decrease in the Terms of Trade.
Effects of changes in TOT on exchange rates
A strong terms of trade leads to an increase or appreciation of the AUD.
High export prices, increases the demand for the AUD, which increases its value/price.
A higher Australian dollar is great for consumers who import goods from overseas. But it is also a disadvantage for
Australian producers who canβt compete against cheaper imports and
Exporters who are not in the mining sector as it reduces their international competitiveness.
Effect of higher TOT on consumers
Imported goods become cheaper relative to exports, increasing purchasing power for households.
Effects of higher TOT on producers
Exporters benefit as higher export prices improve profits for industries like mining and agriculture.
Businesses that rely on imports will benefit as lower import prices reduce production costs
Effects on TOT increase on gdp growth, employment, living standards, inflation, goverment revenue
GDP Growth: Higher export revenues boost national income and economic output increasing GDP growth.
Employment: Increased export demand will create jobs in key industries.
Living Standards: Higher incomes improve purchasing power and overall welfare and living standards.
Inflation: There could be inflationary pressures, especially in sectors tied to resource exports, as wages increase, demand increases and costs increase.
Government Revenue: Higher company profits and incomes increase tax revenue, enabling more public spending.
Potential causes of Increase in TOT
An increase in commodity prices
A drought increasing farming prices
A fall in global oil prices
A fall in manufacturing costs
Technology improving ICT prices
Potential causes of decrease in TOT
A decrease in commodity prices
An increase in global oil prices
An increase in supply issues
An increase in manufacturing costs
Effects of increase in TOT
Increase in the Trade Balance
Increase in Real GDP, Economic Growth, National Income and Living Standards
Decrease in the unemployment rate
Increase in government tax revenue
Increase in the inflation rate
Australian Dollar (AUD) appreciation
