Australian Wine Exports to the Market of the USA - Assignment Example

Assignment Article 1) The economy of USA has been experiencing a period of recession for the past few years. The financial crisis originated in the mortgage market of sub-prime loans and gradually affected the other sectors of the economy including the global economy. As a result of the recession, Australian wine exports to the market of USA have reported a decrease. In the Foreign Exchange Market, the currency of one nation is traded in exchange of the currency of another nation. The foreign exchange rate between two currencies is determined by the market forces of supply and demand. In this market, when the supply of one currency decreases, the demand for the other currency simultaneously falls. When the Australian exports of wine to the US market decrease, this indicates that US citizens are supplying less US dollars to buy less of Australian dollars in exchange which are required to buy a smaller quantity of exports. This in turn will lead to depreciation in the foreign exchange value of the Australian dollar. (Jackson, McIver, Wilson 2011) Dollar/AUD Depreciation of the AUD Quantity of AUD (2) A strong Australian dollar indicates a high value of the currency with respect to the other currencies of its partner trading nations. When the Government maintains a strong currency, it prevents the currency from devaluating. Under the Aggregate Expenditure Model: AE/AD/GDP = C + I +G + (X-M)…………… (1) where AE/AD/GDP: Aggregate Expenditure/Aggregate Demand/Gross Domestic Product C: Consumption Expenditure of households I: Investment Expenditure of Businesses G: Government Expenditure X: value of exports M: value of imports If Australia maintains a strong currency, its trading partners will be discouraged to buy Australian exports. Therefore, the value of the country’s exports will fall. Thus in equation (1), X falls. Since X is an important determinant in the Aggregate Expenditure of an economy, a decrease in X causes the AE of Australia to fall. The AE in turn determines the GDP of the country. With a decrease in AE, the GDP of the nation will decrease. A decrease in the GDP cannot be a healthy sign for an economy. Thus, if Australia maintains a strong currency this might prove to be a threat to the overall economy of the nation. AE Real GDP (3) The Aggregate Expenditure (AE) model is expressed with the help of equation (1) AE = C + I + G + (X-M)…………… (1) When the Australian wine industry spends money on a promotion campaign, the investment I increases In the short run, this will have a positive effect on the Balance of Payments (BOP). The advertisement campaign will make Australia’s regional wines more attractive to the US customers and they will buy more of this wine. Thus Australia’s export of wine rises, i.e X rises. In the short run, exports will increase in Australia’s Balance of Payments and the exchange value of the Australian dollar will appreciate. In the long run, the effect of an increase in investment will be ambiguous. The strong value of the Australian dollar and the availability of cheaper South American wines might cause the US citizens to buy less of Australian wine which they had been encouraged to purchase after the campaign. Depending upon which effect is stronger, X may increase or decrease. If X increases, exports will rise in the Australian BOP and the Australian dollar will appreciate. If X decreases, the converse of this will hold true. (Jackson, McIver & Wilson, 2011) (4) The Theory of Free Trade states that trading of a commodity between two countries will continue till their prices are equalized in both the countries. Following this theory, the trading in wine between Australia and USA will tend to equalize the prices of the Australian wine. Among the two varieties of the Australian wine, trade will tend to equalize the prices of the cheaper variety of bulk wines than the Australian premium wine because there will be a greater demand for the former in the US market and it would be traded in a greater amount than the premium wines. (Jackson, McIver & Wilson 2011) Article 2 (1) The Aggregate Demand (AD) and the Aggregate Supply Curves intersect to determine the equilibrium level of price and output in the economy. The equation of the AD curve has been introduced earlier as: AD = C + I + G + (X-M)…………… (1) The AD Curve is derived from the intersection of the IS and LM curves in the economy. The Aggregate Supply Curve is an upward sloping curve in the short run in the Keynesian model. A higher price of petrol would mean that the consumers would have to spend more in buying the same quantity of fuel. This would leave them with a lesser amount of disposable income and thus their consumption expenditure decreases. Thus in equation (1), C falls. As consumption expenditure falls, the AD tends to decrease too. Alternatively, the higher price of petrol would discourage Australia to import more quantity of the fuel. Thus Australia’s import of petrol falls. In equation (1), M falls. As a result of decreasing imports, the Aggregate Demand in the economy will increase. Thus on one hand, due to decreasing consumption expenditure AD decreases while on the other hand, falling imports create a boost to the AD of the economy. Thus there are conflicting pressures on the economy as a result of the same economic phenomenon. (Jackson, McIver & Wilson 2011) (2) The Government of an economy sometimes increases the interest rate to check inflationary pressures. A situation of continuous increase in prices is called inflation. This usually occurs when there is excess money circulating in the economy and economic agents use this extra money to buy the same amount of goods and services. The prices of the commodities automatically increase. This is called demand-pull inflation because it is caused by excess consumption in the demand side of the economy. In such a situation when the interest rates are increased, loans become more expensive in the loan market. Consumers who are used to taking loans to satisfy their consumption needs will no longer be able to do so. Thus, borrowing of loans decrease which in turn causes the consumption to fall. The amount of money circulating in the economy decreases and the pressure of inflation eases out. In the money market, the LM curve shifts upward to the left and intersects the IS curve at a higher interest rate and a lower output. This further results in a downward shift of the AD curve which intersects the AS curve at a lower level of price and equilibrium output. (Jackson, McIver & Wilson 2011) (1) The higher prices of petrol will have an adverse effect on the cost of living of the Australian citizens and their disposable income. Since petrol is an essential fuel, consumers will still buy it inspite of the increase in its prices. Due to the higher prices, the consumers will have to spend more of their income for purchasing the same amount of fuel. The cost of living of the Australian citizens will increase. They will be left with less amount of disposable income for spending on other items of consumption. Thus, consumption expenditure will decrease. AD = C + I + G + (X-M)…………… (1) (3) In equation (1), C falls. As a result, the Aggregate Demand in the economy also decreases. This leads to a contraction of the GDP. (Jackson, McIver & Wilson 2011) (4) Inflation originating from high petrol prices can be controlled by either monetary policy measures or fiscal policy measures. Raising the interest rates is a monetary policy instrument for controlling inflation. The LM curve in the money market shifts to the left which results in a downward shift of the AD curve. Alternatively, inflation can also be controlled by fiscal policy measures. In equation (1) AD = C + I + G + (X-M)…………… (1) when the Government reduces its own spending G, this results in a decrease in the Aggregated Demand in the economy i.e. AD falls. In the goods market, the IS curve shifts downwards to intersect the LM curve at a lower equilibrium interest rate and a lower level of output. Consequently, the AD curve also shifts downward intersecting the AS curve at a lower level of equilibrium price and output. Thus, the Australian Government can combat the inflation from higher petrol prices by reducing its expenditure. (Jackson, McIver & Wilson 2011) Price The Price Level Falls Quantity References 1. Jackson John, McIver Ron & Wilson Edgar Macroeconomics Australia 2011 Read More