10 Questions
When Australia has low commodity prices, the TOT will improve.
False
When the $AUD appreciates, the TOT improves because exports become cheaper.
False
An increase in the cost of manufactured goods leads to a TOT improvement.
False
In 2022, Australia's TOT increased from 80 to 125, showing an improvement in both TOT and trade balance.
True
After COVID-19, there was a decrease in Australia's TOT to 100.
False
During times of expansion, the current account is likely to be in surplus.
False
During a trough, import spending decreases causing the current account to go into surplus.
True
An increase in commodity prices generally leads to a decrease in the Terms of Trade.
False
If a Chinese steel company imports iron ore for a higher price, it would likely decrease Australia's export revenue.
False
A Current Account deficit means there is more money flowing out of the country than flowing in.
True
Study Notes
Terms of Trade (TOT)
- TOT measures the amount of imports a country can purchase per unit of exports.
- When TOT increases, a country's wealth increases, and they can buy more imports with the same amount of exports.
- When TOT decreases, a country's wealth decreases, and they can buy less imports with the same amount of exports.
Factors Affecting Terms of Trade
Commodity Prices
- Commodity prices refer to the earnings from exports (e.g., coal, iron ore).
- High commodity prices improve TOT, increasing export revenue.
- Low commodity prices deteriorate TOT, decreasing export revenue.
Exchange Rates
- Appreciation of the Australian dollar (AUD) increases its value, making imports cheaper and exports more expensive, leading to an improved TOT.
- Depreciation of the AUD decreases its value, making exports cheaper and imports more expensive, leading to a deteriorated TOT.
Cost of Manufactured Goods
- An increase in the cost of manufactured goods decreases TOT, as Australia imports these goods from overseas.
- A decrease in the cost of manufactured goods increases TOT, allowing Australia to buy more imports with the same amount of exports.
Changes in Australia's Terms of Trade
- In the past 10 years, there has been a link between Australia's TOT and trade balance.
- TOT has fluctuated, with a favorable movement in 2022 and a plateau in 2020 due to COVID-19.
Balance of Payments and Business Cycle
Expansion Phase
- Household incomes are higher, increasing import spending and investment.
- Exports become more expensive for trading partners, and imports become cheaper for Australian residents.
- The current account goes into deficit, with more money flowing out of the economy.
Trough Phase
- Household incomes are lower, decreasing import spending and investment.
- Exports become cheaper for trading partners, and imports become more expensive for Australian residents.
- The current account goes into surplus, with less money flowing out of the economy.
Test your knowledge on the relationship between business cycles, household incomes, and current account deficits. This quiz covers the impact of economic expansions on import spending, investment, and export competitiveness.
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