Terms of Trade
The Terms of Trade (TOT) is a ratio of the average prices received for Australian exports relative to the price paid for our imports. A rise in the TOT is generally beneficial for Australia because it results in exporters receiving higher incomes from any given volume of exports, and/or we will be paying less for any given quantity of imports. This increases the value of net exports, boosting both the Balance on Goods and Services in the current account as well raising nominal GDP via an increase in the net exports (X – M) component of aggregate demand. This will ultimately increases real GDP via the increase in both consumption and investment that flows from the growth in national income (e.g. via greater profits and wages). Accordingly, growth in the TOT will not only tend to have a favourable impact on the current account (and the balance of payments more generally), but help to accelerate economic growth and reduce the rate of unemployment. However, it will also lead to an increase in demand inflationary pressure, making it more difficult to achieve price stability over time. To extent that higher inflation worsens competitiveness over time, the boost to the balance of payments will partly be reversed over time.
The rise in the TOT over the past few years (along with the depreciating currency) has been a contributing factor behind the huge increase in the Balance on Merchandise Trade since 2018 and the return to current account surplus in 2019 (the first time in 46 years). The main reasons for the improved terms of trade have been the growth in the global demand for key Australian commodities, particularly natural gas, cola and iron ore.
The chart below highlights the key movements in the terms of trade over the past 10 years:
Course notes quick navigation
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