Terms of Trade.pdf - PEGSnet

TERMS OF TRADE1. What is meant by the Terms of Trade?ResponseThe terms of trade measures the price Australia receives for its exportsrelative to the prices paid for imports.2. The benefits of a strong Terms of Trade?ResponseIf the TOT become favourable or improve a larger quantity of importscan be purchased with a given quantity of exports. This wil have theeffect of increasing living standards and real domestic incometransferred from the rest of the world.Part of this income gain will godirectly to foreigners given that there is significant foreign ownership ofthe resource sector. However , most benefits wil accrue domesticallyeither as higher profits, taxes or royalty payments to governments.Furthermore a strong TOT can improve efficiency in resource allocation,provide an expqnsionary influence on the domestic economy and rduceinflationary pressure(if import prices are falling). By boosting realdomestic income, and the purchasing power of exports, our economicwelfare is increased. Strong TOT can increase business confidence andinvestment can stimulate greater production capacity and an increasedability to meet rising export demand. Economic growth and employmentwill be higher. It is also good news for the current account if the TOTimprovements boosts export revenues.3. In what way can the rising terms of trade improve employment levelsand improve our GDP?Response

4. Why has our TOT been rising?ResponseIt has been rising because Asian source imports have been falling inprice, while rising exports prices have been determined in worldmarkets.Recent improvement in our TOT has occurred due to stronger worldeconomic growth, rising commodity prices and falling import pricesparticularly technology imports,l ike computers, software, etc, whichhave resulted in lower cost pressures and reduced inflationary trends inthe Australian economy.Globalisation has created rising competition which in turn has led toreduced world prices of imports and acted as an incentive forproductivity improvements and cost efficiencies. We have neenfortunate in that we have been a net importer of information andcomunicaation technology based goods which have fallen in price andcontributed to a favourable TOT movment.Government policies have also assisted. Microeconomic reforms whichhave enhanced efficiency and productivity, and increased domesticindustries exposure to international competition. This has changed thecomposition of our exports and imports and directly assisted in TOTstability. On top of that we have had sound fiscal and monetary policy toachieve lower inflation which has been assisted by more stable TOTleading to stronger economic growth.