Explain the basis for international trade and evaluate the effects of globalisation, protection and exchange rates on the Australian economy.

What this dot point is asking

International trade lets countries buy and sell goods, services and capital across borders. The economic case for trade rests on the theory of comparative advantage.

Comparative advantage and gains from trade

Comparative advantage means a country should specialise in producing the goods it can make at the lowest opportunity cost, then trade for the rest. Even if one country is better at producing everything (absolute advantage), both still gain by specialising where their relative cost is lowest. Australia has a comparative advantage in resources such as iron ore, coal, natural gas and agricultural products, which dominate our exports, while we import manufactured goods and many services. Specialisation raises total output, lowers prices, widens consumer choice and allows economies of scale.

Protection

Protection refers to government policies that shield domestic industries from foreign competition. The main methods are:

• Tariffs: a tax on imports that raises their price, protecting local producers but raising prices for consumers and creating inefficiency.
• Subsidies: payments to domestic producers that lower their costs.
• Import quotas: limits on the quantity of a good that can be imported.

Arguments for protection include defending infant industries, saving jobs and national security. Arguments against are that protection raises prices, props up inefficient firms, invites retaliation and reduces the gains from trade. Since the 1980s Australia has substantially reduced tariffs and embraced freer trade, and it has signed many free trade agreements, for example with China, Japan, Korea and through regional deals.

The balance of payments

The balance of payments records all transactions between Australia and the rest of the world. It has two parts. The current account records trade in goods and services, plus primary income (such as interest and dividends) and secondary income. The capital and financial account records flows of investment and borrowing. The terms of trade, the ratio of export prices to import prices, strongly affect Australia's national income; a commodity boom that lifts export prices improves the terms of trade.

Exchange rates

The exchange rate is the price of the Australian dollar in terms of another currency. Australia uses a floating exchange rate, so the dollar is set by demand for and supply of the currency in the foreign exchange market. Demand for the dollar rises with exports, foreign investment inflows and higher domestic interest rates.

• A depreciation (the dollar falls) makes exports cheaper and more competitive and imports dearer, helping exporters but adding to imported inflation.
• An appreciation (the dollar rises) makes imports cheaper and exports less competitive.

Globalisation

Globalisation is the growing integration of economies through trade, investment, technology, finance and the movement of people. For Australia it has brought lower prices, access to capital, new technology and larger markets, while increasing exposure to global downturns, commodity price swings and competition for local industries.

A strong response links comparative advantage to the gains from trade, evaluates protection on efficiency and equity grounds, and traces how exchange-rate moves flow through to trade, growth and inflation.