ATAR Notes: Forum
VCE Stuff => VCE Business Studies => VCE Subjects + Help => VCE Economics => Topic started by: Elayg6 on October 28, 2018, 12:13:33 pm
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How does the TOT and exchange rate influence the CAD and also what other factors influence it? Thanks!
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The terms of trade is a ratio of export prices to import prices where to export the buyer needs domestic dollars and to import the buyer needs foreign dollars... if tot falls exports are relatively cheap and imports are relatively expensive leading to a current account surplus all else equal and vice versa
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Please correct me if I’m wrong, but I believe that if the terms of trade were to fall, that would mean the average price of Australian exports were relatively lower when compared to the price of foreign imports. Ceteris paribus, I think this would most likely impact negatively on the balance of goods and services in the long term, and thus increase the current account deficit, not lead to a current account surplus.
A higher exchange rate would also likely lead to an increase in the current account deficit. A higher exchange rate impacts on exports in three main ways:
- businesses that are price takers and rely on the world price (in USD) of their goods when selling on international markets will receive less income
- exporters that are price makers, such as the education and tourism industries, will be less internationally competitive as they are relatively more expensive for foreign buyers
- import values should increase because imports are relatively cheaper for Australians
All of these demand side impacts generally result in lower demand for Australian exports and higher demand for foreign imports, reducing the balance on goods and services, and increasing the size of the current account deficit.
Factors that influence the current account can be split into two groups - structural factors and cyclical factors
Structural factors:
- Australia's savings/investment gap: since Australia is a relatively young economy with relatively few savings in comparison to the level of investment required to grow the economy, Australians must borrow from overseas in order to finance investment expenditure, increasing the current account deficit
- Australia's relatively low international competitiveness: Australia is ranked outside the top 20 countries in the world in terms of levels of international competitiveness, and has been for many years. As such, Australian products aren't very competitive on the global market, so Australia usually records a deficit on the balance of goods and services. This influences the structural current account deficit.
Cyclical factors:
- Australia's economic growth and factors affecting Australia's economic growth influence the current account. Generally, when economic growth increases, the size of the current account deficit also increases, as the savings/investment gap grows and increased investment spending on imports occurs. Therefore, aggregate demand factors tend to influence the CAD, with an increase in AD resulting in an increase in the CAD. Usually, the only exceptions to this rule are economic factors directly relating to the global economy (ie. overseas economic growth and exchange rates) because economic growth caused by these factors is export-driven growth, and should result in a decrease in the size of the CAD.
I hope this helps! Good luck with the exam tomorrow ;D
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Many good points... But if imports are more expensive we'll substitute for domestic products and if exports relatively cheap we'll export more decreasing cad which is in aud not foreign dollars... I.e. during mining boom tot increased meaning aud appreciated and people shopped overseas because you could buy more with each aud and exports priced in aud decreased as it was expensive to buy goods priced in aud but this is all relative as there was increased demand for exports anyway... or China that keep there currency low to at once export more and also to encourage citizens to buy products at home where China's exports and current account surplus have lead to it's exponential growth... Anyway two examples
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Sorry, which part of my response are you questioning? I don't entirely understand.
Respectfully, according to the VCE economics course, a fall in the TOT should result in an increase in the CAD, and a rise in the exchange rate should also cause an increase in the CAD, ceteris paribus.
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https://www.economicshelp.org/blog/68/trade/balance-of-trade-and-terms-of-trade/
"How terms of trade affects the balance of trade (current account)
An improvement in the terms of trade means that export prices are increasing faster than import price. Therefore, ceteris paribus, a rise in export prices will cause a fall in the quantity exports. Relatively cheaper import prices will increase the quantity of imports.
Therefore, it is likely that with lower exports the current account deficit (+ trade deficit) will get worse, i.e. bigger deficit."
It's actually complicated than you think.. it is true in the short run a depreciation will lead lead to a deteriorating current account as imports are sticky I.e. J curve... but in the long run it's argument above reversed I.e. A surplus
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Yeah alright, I completely agree with what you're saying, and if there was a question about the effect of the TOT on the CAD that would certainly be useful in fleshing out a response. However, in terms of the VCE course, the end result is that a decrease in the TOT should, in the long term, place upwards pressure on the size of the current account deficit. Previous exams, both textbooks, and relevant bodies such as the VCTA and CPAP support that answer. Therefore, whilst in the short term there is the response as you describe, in the vast majority of cases that would not be enough to receive full marks, at least in my understanding, particularly as the J-curve isn't explicitly part of the course.
Taken straight from the economics down under 3/4 textbook:
Effects of the terms of trade on Australia’s CAD
When the terms of trade rise or fall (due to changes in our export prices relative to import prices), this will affect the values of both exports and imports and hence the size of Australia’s CAD.
A fall in the TOT tends to cause the CAD to rise. This is because when we receive lower prices, for example, it often means that there is a relatively weaker demand internationally for our exports. In turn, the value of credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase the value of import debits.
A rise in the TOT usually results in a decrease in the CAD due to higher prices causing a rise in the value of credits for exports relative to debits for imports
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Ok can't help then... as per your journal two hard 3/4s in year 11 is a steep learning curve but what doesn't kill you makes you stronger :)