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1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

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Terms of Trade (tot)


The TOT is a ratio of Australian exports prices to import prices (Px/Pm).  If the TOT increases, there must be a rise in the average prices received for Australian exports relative to the price paid for our imports.  A rise in the TOT is beneficial for Australia because it means that exporters are receiving higher incomes from export sales, and/or we are paying less for our imports.  This means that incomes increase in the economy (starting from those sectors experiencing the TOT boost, such as mining), causing an increase in C, I, AD and real GDP to increase.  This makes it easier to achieve the government's economic growth goal, boosting the demand for labour and employment, bringing us closer to achieving full employment.  Accordingly, for reasons already discussed, higher growth and lower unemployment are likely to lead to greater equity in the distribution of income.  With respect to the impact on external stability, the higher TOT should increase the value of net exports (X-M), therefore boosting the Balance on Merchandise Trade, reducing the CAD and decreasing NFLs (NFD or NFE)


 

With respect to low inflation, the rising TOT can assist if the TOT has risen as a result of a fall in the world price of imports. This is because Australian importers experience lower prices, which in the case of some consumer items, directly reduce the CPI, and in the case of capital or intermediate items, reduces the costs of production and leads to medium-term reductions in inflation (on the supply side). However, if the TOT has increased as a result of rising world prices of our exports, this can actually contribute to inflationary pressure for two main reasons.  Firstly, the higher export incomes add to national income and inflationary pressures.  Secondly, as more goods/services are offered in export markets, it adds to capacity constraints for local production, fuelling inflationary pressure.  


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