| Date | May 2017 | Marks available | 8 | Reference code | 17M.2.HL.TZ0.02 |
| Level | Higher level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Discuss | Question number | 02 | Adapted from | N/A |
Question
Australia’s terms of trade
- Australia’s terms of trade fell sharply in the three months through to June 2015, the largest fall since the global financial crisis of 2008. Official trade price data released by the Australian Bureau of Statistics (ABS) imply the terms of trade slumped by about 5.8% from the March quarter. This may worsen the current account deficit.
- The terms of trade index is now significantly below its September 2011 peak because of ongoing falls in the prices of iron ore, coal and energy. This is of critical importance given Australia’s growing reliance on income from exports of liquefied natural gas.
- “The golden age of commodity-driven income growth is long gone,” said an economist at Commonwealth Bank. “The continued fall in the terms of trade reflects a pronounced fall in the purchasing power of Australian households and businesses. This has been a familiar theme over the past few years,” he said. “Basically, falling commodity prices, namely iron ore and coal, have weighed heavily on export revenues and therefore, real gross national income growth.”
- Falling prices for exports are likely to damage the Australian government’s revenue expectations and to damage hopes for any rebound in economic strength in the near future.
- While the quantity of export shipments – chiefly iron ore – continues to break records,the revenues received by the nation’s biggest exporters continue to fall and several key economists fear that this may lead to a recession. This would break a 24-year run of unbroken economic growth.
- The Australian dollar’s 0.4% fall in the exchange rate has done little to offset this effect, and the Reserve Bank of Australia continues to signal that it may take further measures to lower its current price of around AU$1 = US$0.73.
- The ongoing terms of trade collapse highlights the urgency for governments and companies to accelerate efforts at encouraging productivity. The manager of the Reserve Bank of Australia said, “Australia’s dreadful productivity effort over the last decade was masked by the rapidly increasing terms of trade up until 2013. This kept our income growing but the weakness now is harshly exposed as commodity prices slide”.
Figure 1 – Export and import indices for Australia
[Sources: Extract: Adapted from Fairfax Syndication, www.afr.com/news, 30 July 2015 Table: ABS data used with permission from the Australian Bureau of Statistics, July 2015, www.abs.gov.au]
Define the term current account deficit indicated in bold in the text (paragraph 1).
Define the term gross national income indicated in bold in the text (paragraph 3).
Using a definition of price elasticity of demand, explain why “the revenues received by the nation’s biggest exporters continue to fall” (paragraph 5).
Using a definition of the terms of trade, explain the terms of trade change in Australia from 2011 to 2015 (Figure 1).
Using information from the text/data and your knowledge of economics, discuss the possible effects of the fall in Australia’s terms of trade on the Australian economy.
Markscheme
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that it is when the net flow of money from trade in goods and services is negative or that the value of imports is greater than the value of exports.
2 Accurate definition. [2]
An explanation that it is when the net flow of money from trade in goods and services and income flows and/or transfers is negative.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that it is the total value of output
2 Accurate definition. [2]
An explanation that it is the total value of incomes (or output or expenditure) earned by a nation’s factors of production regardless of where the assets are located or gross domestic product plus net property income from abroad.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 The written response is limited. [1-2]
For providing an accurate definition of price elasticity of demand (or formula) or for noting that demand for commodities tends to be inelastic and since prices of exports are falling, total revenue will be falling because the percentage change in quantity is less than the percentage change in price.
2 The written response is accurate. [3-4]
For providing an accurate definition of price elasticity of demand (or formula) and for noting than demand for commodities tends to be inelastic and since prices of exports are falling, total revenue will be falling because the percentage change in quantity is less than the percentage change in price.
NB the definition of PED may be integrated with the explanation, and does not have to be separately defined.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 The written response is limited. [1-2]
For defining the terms of trade as the ratio of a country’s average export prices to their average import prices (or for giving the equation Terms of trade = Average export prices / Average import prices x 100) or for explaining that there was a fall in the terms of trade index that could have been caused by either the fall in the average prices of Australia’s exports and/or the increase in the average prices of Australia’s imports.
2 The written response is accurate. [3-4]
For defining the terms of trade as the ratio of a country’s average export prices to their average import prices (or for giving the equation Terms of trade = Average export prices / Average import prices x 100) and for explaining that there was a fall in the terms of trade index that could have been caused by either the fall in the average prices of Australia’s exports and/or the increase in the average prices of Australia’s imports.
NB [1] may be given for the explanation that the terms of trade is an indication of the amount of exports needed to buy imports.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Level
0 The work does not meet a standard described by the descriptors below. [0]
1 Few relevant concepts are recognized.
There is basic knowledge/understanding. [1–2]
2 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is some attempt at application/analysis. [3–5]
3 Relevant concepts are recognized and developed in reasonable depth.
There is clear knowledge/understanding.
There is effective application/analysis.
There is synthesis/evaluation, supported by appropriate theory and evidence. [6–8]
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Responses may include:
- definition of terms of trade
- it may harm the current account balance (paragraph 1), depending upon PED
- Australia's reliance on export income of energy (paragraph 2)
- fall in purchasing power for households and businesses (paragraph 3)
- pressure on real GDP growth (paragraph 3)
- effects upon government revenue (paragraph 4)
- the effect on revenues of domestic producers and thus a fall in investment – “may lead to a recession” (paragraph 5)
- the pressure to improve productivity (supply side policies?) (paragraph 7)
- the need to sell more exports to cover imports and the overuse of resources, resulting in negative externalities
- problems of being dependent on commodity exports and price volatility.
Any reasonable discussion.
