Reasons for Trade
Advantages and Disadvantages of Trade
Absolute, Comparative & Competitive Advantage
Exchange Rates
Appreciation & depreciation exchange rates
100
Define a monetary union as a form of economic integration
A monetary union is a form of economic integration where member countries share a common currency and allow the free movement of capital and labour between participating nations.
100
Define international trade.
International trade refers to the exchange of goods and services between countries through exports and imports.
100
Define absolute advantage.
Absolute advantage occurs when a country is able to produce a good or service using fewer resources or at a lower cost than another country. This allows the country to produce more output from the same level of resources.
100
Define an exchange rate.
An exchange rate is the value of one country’s currency expressed in terms of the currency of another country.
100
Draw a demand and supply diagram for a currency in the foreign exchange market to show an appreciation of the currency. Clearly label all axes, curves, and equilibrium exchange rates.
Decrease in supply would also be correct
200
Explain the difference between a credit and a debit in the current account when analysing an economy.
Credits are transactions that involve money flowing into the country from overseas, such as exports of goods and services.
Debits are transactions that involve money flowing out of the country to overseas, such as imports of goods and services.
200
Explain one advantage of international trade for consumers.
International trade increases consumer choice and competition between producers. Greater competition can lead to lower prices and improved product quality, increasing consumer welfare.
200
Define comparative advantage.
Comparative advantage occurs when a country can produce a good at a lower opportunity cost than another country. This means the country gives up less of another good when producing that product.
200
If 1 AUD = 0.80 USD, calculate how many Australian dollars 1 US dollar is worth. Show your working.
1" AUD"=0.80" USD"
To convert to 1 USD: 1÷0.80=1.25
Therefore: 1 USD=1.25 AUD
200
Identify two ways a currency can appreciate.
A currency can appreciate if:
1. Demand for the currency increases, for example due to higher foreign demand for exports or increased foreign investment.
2. Supply of the currency decreases, for example if imports fall or there is a reduction in capital outflows.
300
Define external stability and explain one way trade can influence external stability.
External stability refers to a situation where a country experiences no unwanted movements in foreign reserves and maintains a sustainable balance of payments position.
Trade influences external stability through its impact on the current account. Strong export performance increases export revenue, improving the current account balance and reducing reliance on foreign capital inflows, helping to stabilise foreign reserves.
300
Explain one disadvantage of international trade for domestic producers.
International trade can expose domestic producers to increased foreign competition. If overseas producers have lower costs of production, domestic firms may lose market share, leading to lower profits, reduced production and possible job losses.
300
Using a production possibility frontier (PPF) diagram, explain how opportunity cost influences a country’s decision to specialise.
A PPF diagram shows the maximum combinations of two goods that a country can produce using its available resources.
The slope of the PPF represents the opportunity cost of producing one good in terms of another. A country will specialise in producing the good with the lower opportunity cost, as this allows it to maximise production efficiency.
300
Explain the difference between a fixed exchange rate system and a floating exchange rate system.
A fixed exchange rate system is where the value of a currency is pegged to another currency, a basket of currencies or a commodity, and is maintained through government or central bank intervention.
A floating exchange rate system allows the value of a currency to be determined by the forces of supply and demand in the foreign exchange market, with no direct government intervention.
300
Define terms of trade and explain two ways an improvement in the terms of trade can occur.
Terms of trade is a statistical concept that measures the relationship between a country’s export prices and import prices.
An improvement in the terms of trade occurs when this ratio increases.
An improvement can occur when:
- Export prices rise faster than import prices
- Import prices fall while export prices remain constant
400
Explain one transaction that would be included in the income section of the current account.
One transaction included in the income section is wages earned by Australians working overseas. These payments are income earned from labour, not from selling goods or services, and are recorded in the income section of the current account.
400
Explain how the use of different currencies can complicate international trade.
International trade involves exchanging different currencies, exposing exporters and importers to exchange rate fluctuations. Changes in exchange rates can make exports more expensive or cheaper and increase uncertainty for businesses. This uncertainty can discourage trade, affect pricing decisions, and reduce profit stability for firms engaged in international trade.
400
Using a production possibility frontier (PPF) diagram, explain how absolute advantage influences a country’s decision to specialise.
A PPF diagram shows the maximum combinations of two goods that a country can produce using its available resources.
A country has an absolute advantage in the good it can produce in greater quantities using the same level of resources. This is shown on a PPF by the ability to produce more of one good compared to another country.
As a result, a country will choose to specialise in the production of the good in which it has an absolute advantage, as this allows it to increase total output by allocating resources to the most productive use.
400
Explain the difference between an appreciation and a depreciation of a currency.
An appreciation occurs when the value of a floating currency rises relative to other currencies.
A depreciation occurs when the value of a floating currency falls relative to other currencies.
Both terms apply only to floating exchange rate systems and reflect changes driven by market forces.
400
Explain how an increase in imports can lead to a depreciation of a country’s currency. Use a demand and supply diagram in your response.
An increase in imports causes domestic consumers to exchange more domestic currency for foreign currencies, increasing the supply of the domestic currency in the foreign exchange market.
500
Define internal stability and explain how an improvement in a country’s trade balance can impact internal stability.
Internal stability refers to a state of the economy where there is full employment and low, stable inflation.
An improvement in a country’s trade balance, such as through increased exports, raises aggregate demand. Higher export demand encourages firms to expand production and hire more workers, reducing unemployment. This increase in economic activity supports growth and improves internal stability, provided inflationary pressures remain controlled.
500
Explain how an increase in trade restrictions in an economy could affect its trade balance and internal stability.
Increased trade restrictions can reduce imports, which may improve the trade balance in the short term. However, reduced competition and higher prices can increase inflation and disrupt production. If export industries are affected by retaliation from trading partners, employment may fall, worsening internal stability through higher unemployment and inflation.
500
Identify and explain one factor of Porters Diamond Model to determine national competitive advantage.
Factor Conditions
Factor conditions refer to a nation’s endowment of production inputs such as labour, natural resources, capital, infrastructure and technological capability. According to Porter, having abundant basic factors (like unskilled labour or raw materials) does not necessarily create a competitive advantage. Instead, it is the presence of advanced and specialised factors—such as highly trained workers, sophisticated research facilities, and modern transport and communication systems—that gives nations an edge. Importantly, Porter argues that these specialised factors are not inherited; they are deliberately created through long‑term investments in education, skills training, innovation and infrastructure. This means a country can strategically build its competitive strength by developing the capabilities most relevant to its key industries.
Demand Conditions
Demand conditions refer to the nature and sophistication of consumers within the domestic market. When local buyers are highly discerning and have evolving needs, they push firms to innovate, improve quality, and anticipate emerging global trends. A strong and demanding home market therefore acts as a testing ground, forcing firms to develop products and services that meet high standards before entering international competition. This early exposure provides businesses with deep insights into consumer behaviour, enabling them to adapt faster and more effectively to overseas markets. Overall, a robust domestic demand becomes a catalyst for international competitiveness by driving firms to continually refine and differentiate their offerings.
Related and Supporting Industries
Competitive advantage is strengthened when a nation possesses clusters of efficient, innovative, and internationally competitive supplier and related industries. These industries support firms by supplying high‑quality inputs, sharing technological developments and collaborating on problem‑solving and innovation. When suppliers are geographically close and competitive themselves, firms benefit from faster communication, reduced costs, and access to cutting‑edge processes or materials. The presence of strong related industries also encourages knowledge spillovers and joint research, fostering an environment where innovation can thrive. Ultimately, these inter‑industry linkages create a network of mutually reinforcing strengths that enhance national competitiveness.
Firm Strategy, Structure and Rivalry
The way firms are created, organised and managed—along with the intensity of domestic rivalry—plays a major role in building national competitive advantage. Porter argues that strong local competition is beneficial because it compels firms to continually innovate, reduce costs and differentiate their products to gain an edge. Nations whose cultural and organisational norms encourage discipline, flexibility, long‑term investment and risk‑taking tend to foster stronger firms. Likewise, business environments that reward efficiency and innovation help companies develop the resilience and capabilities needed to succeed globally. In essence, vigorous domestic rivalry acts as a training ground that prepares firms for the pressures of international markets.
500
Explain how a depreciation of a country’s currency can affect imports and exports.
When a currency depreciates, exports become cheaper for foreign buyers, increasing international competitiveness and export demand. At the same time, imports become more expensive for domestic consumers, which may reduce import volumes. As a result, a depreciation can improve the trade balance by increasing exports and reducing imports.
500
Using demand and supply diagrams, explain two different causes of a currency appreciation.
Cause 1: Increase in demand for exports
• Demand curve shifts right
• Exchange rate rises → appreciation
Cause 2: Decrease in supply of the currency
• Supply curve shifts left
• Exchange rate rises → appreciation