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Learning Objectives

Topic 10
Macroeconomics
in an Open
Economy
Chapter 19

1. Explain the main components of the balance
of payments and understand how it is
calculated.
2. Explain how exchange rates are determined
and how changes in exchange rates affect the
prices of imports and exports.
3. Analyse the determinants of exchange rates.
4. Explain the link between saving, investment &
the current account balance.
5. Is Australia’s foreign debt a problem?

Part I
Balance of
Payments

An Open Economy
Open economy: An economy that has
interactions in trade and finance with
other economies.
Closed economy: An economy that has
no interactions in trade or finance with
other economies.
W hy do countries engage in trade?
Trade can be in goods, services & financial
assets

What drives international trade?
Comparative advantage is the
fundamental force that generates trade
between nations
The basis for comparative trade is
differences in opportunity costs between
countries.
A country has a comparative advantage
in producing a good if it can produce that
good at a lower opportunity cost than
any other country.

What drives international trade?
Which is more important: exports or
imports?
Exports increase producer surplus but
decrease consumer surplus but the
gain > loss
Imports increase consumer surplus but
decrease producer surplus but the gain
> loss
Countries gain from both exports &
imports
Countries lose from restricting trade

Gibson and Fraser: Business Law 4e © 2009 Pearson Education Australia

The current account

The balance of payments
The balance of payments is a
summary of financial transactions
between one country and others over
a period of time.

The current account records trade in
goods, services & income. It consists of
balances on

This summary records the nature and
value of inflows and outflows of goods,
services, income and financial assets.

Merchandise trade (goods)

The balance of payments is divided
into two accounts

Income

Services (e.g. tourism, education)

The current account

Primary income - dividends, profit
&interest payments

The capital & financial account

Secondary income – foreign aid

Balance of trade

Balance on goods and services

Balance of trade in goods and services:
The difference between the value of the
goods and services a country exports and
the value of the goods and services a
country imports.
Australia’s trade balance varies from
surplus to deficit

10 000

Millions of dollars

5 000

2007-08
$25bn deficit
2008-09
$8bn surplus
2009-10
$4bn deficit
20010-11
$20bn surplus (est.)
Is it better to have a trade surplus or a trade deficit?

-5 000
-10 000
-15 000
-20 000

19
6
19 0
6
19 2
6
19 4
66
19
6
19 8
7
19 0
7
19 2
7
19 4
76
19
78
19
8
19 0
8
19 2
8
19 4
8
19 6
8
19 8
9
19 0
92
19
94
19
9
19 6
9
20 8
00
20
0
20 2
0
20 4
06
20
08

-25 000

Net income, Australia

Current Account: Net Income
Net income is always in deficit for
Australia. Why?

0
-5
Billions of dollars

-10
-15
-20
-25
-30
-35
-40
-45
-50
19
60
19
63
19
66
19
69
19
72
19
75
19
78
19
81
19
84
19
87
19
90
19
93
19
96
19
99
20
02
20
05
20
08

Australia’s high level of investment
relative to saving leads to Australians
borrowing from overseas – the interest
repayment on loans is the largest deficit
component of net income.
Foreign investment in Australia generates
dividends and profits which flow back
overseas.

Balance on goods and
services
Balance on goods

Gibson and Fraser: Business Law 4e © 2009 Pearson Education Australia

Balance of Payments Australia
Current Account 2009-10

$billion

Export of goods

201

Imports of goods

204

Net services

-1

Balance on goods & services

-4

Primary income

-48

Secondary income
Current Account Balance...
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