Unit 3 AOS 3

Question 1

Cause of Current Account Deficit - CAD

Answer 1

Structural causes
Investment is required to maximise our growth potential.
However the savings required to fund this investment cannot be raised entirely in Australia (Savings-Investment Gap) Therefore foreign funds flow into Australia (borrowing recorded in the Capital and Financial Accounts).
This builds up our net foreign debt (NFD) which has large outflows in the Current Account to pay for the interest on this debt.

Structural causes
Australia’s relatively low international competitiveness is also to blame. High costs and low efficiency puts pressure on the current account.
Our low international competitiveness means that at times, we import more than export, and when we have had a surplus in BOGS, it is largely due to our mineral exports.

Cyclical causes
Cyclical causes of the CAD fluctuate based on the phase of the business cycle or economic activity.
During strong periods of AD, the CAD will increase because of more borrowing from overseas to fund investment which results in increased primary income outflows to cover the interest repayments on external borrowing.
There is also likely more spillover into import spending, more likely resulting in a deficit for the trade balance.

Question 2

Terms Of Trade meaning

Answer 2

is a ratio of the average prices received for Australian exports relative to the average prices paid for our imports.

Question 3

Factors that Influence terms of trade

Answer 3

Forces of supply and demand. For example, an increase in global demand for Australian exports will increase export prices (and improve TOT) and decrease in demand will see prices fall (decreasing TOT). Changes to the level of supply of goods we exports is also going to affect the prices of exports and therefore TOT.

Changes to demand and supply of goods and services imported by Australia will affect import prices and TOT.

Question 4

Effect of movements in TOT

Answer 4

Growth in TOT - a rise in export income - increased net exports and AD.
Increased AD - increased demand for labour - downward pressure on U/E rate
Improved TOT - reduced price of imports - lower costs of production and downward pressure on prices.

Question 5

Effect of Exchange Rate movements on Current Account Balance

Answer 5

Higher AUD Values
Lower net export demand, leading to a smaller Balance of goods and services surplus and a larger current account deficit or smaller surplus

Lower AUD Values
Increases net export demand, leading to a larger Balance of goods and services surplus and a smaller current account deficit or larger surplus

Question 6

Effect of Exchange Rate movements on macroeconomic goals & Living Standards

Answer 6

AUD Depreciates
demand side effects on economic growth are positive
positive effects are reduced by supply side factors as Lower AUD means imports are more expensive

Higher AUD Values
Delays economic growth and material living standards as measured by real GDP per capita

Lower AUD Values
Stimulates economic growth and material living standards as measured by real GDP per capita

Question 7

The relationship between the Current Account and the Capital and Financial Accounts

Answer 7

The current account is always offset by the capital and financial account so that the balance of payments equals zero

Question 8

Balance of Payments

Answer 8

It is an accounting summary of where money is received from other countries and where Australia spends money in the rest of the world.

Components: 
Current Account 
- The Balance on Merchandise Trade (BOMT)
- Net Services
- Net Primary Incomes
- Net Secondary Incomes
Capital and Financial Accounts