TERMS OF TRADE

Domestic economic events are not the only influence on national income. In particular, changes in the relative prices of Australia’s exports and imports (the terms of trade) affect real national income.

Imports give the residents of a country access to goods and services that cannot be produced (or cannot be produced as cheaply) in the domestic economy. Exports are one important way of funding purchases of imports, and of maintaining levels of domestic production, income and employment. Thus, changes in the terms of trade can affect the volume of goods and services that must be exported to fund a given volume of imports.

The goods and services that make up a country's exports are typically quite different from those that make up its imports – for example, agricultural and mining products account for a fairly large proportion of Australia’s exports, whereas manufactured goods and some services account for a large proportion of our imports.

During much of the 20th century, there was a general trend toward falling prices of primary commodities (especially agricultural products) relative to other traded goods and services. This reflected both shifts in the composition of worldwide demand and supply, and the effect of improvements in productivity. Around that long-term trend, there have also been oscillations (each lasting several years) that have reflected short-to-medium run changes in demand and supply conditions.

Between 1998-99 and 2008-09, Australia's terms of trade have undergone an unprecedented rise of 75%, reflecting changes in both the prices and the composition of traded goods and services. Export prices grew by 86% while import prices grew by just 9%. The rise in export prices was driven by increases in coal and metal ores while falls in prices of many manufactured goods helped keep prices of imports down (ABS 2009a).