This essay uses chains of analysis and evaluation to examine the effects of significant improvement in a country's terms of trade on the achievement of its macroeconomic objectives. A judgement is also made deciding the overall impact.
Evaluate the effects of significant improvement in a country’s terms of trade on the achievement of
its macroeconomic objectives.
The terms of trade are defined as the ratio between average export prices and
average import prices. An improvement in a country’s terms of trade occurs
when average export prices rise or when average import prices fall.
Macroeconomic objectives are the performance aims that a government hopes
to achieve.
An improvement in the terms of trade may help reduce and stabilise the
inflation rate of a country. As Taiwan’s terms of trade improves, this implies
that export prices are higher than import prices. Higher export prices may lead
to a fall in international demand, as goods become more expensive. Thus,
causing a fall in net trade (x-m). As net trade worsens, ceteris paribus, this
causes aggregate demand to fall. In the diagram above, the initial equilibrium
point is at P1Y1. Due to a fall in aggregate demand, the AD curve shifts to the
left. This then reduces inflationary pressures on the economy. Consequently,
causing the price level to fall from P1 to P2 and the real GDP level to fall from
Y1 to Y2. The new equilibrium point is now at P2Y2. Therefore, as Taiwan’s
terms of trade improves, this will help aid the Taiwanese government in
achieving a stable inflation rate. However, this conflicts with the aim of
achieving higher economic growth. As a result of an improved terms of trade,
due to a fall in AD, Taiwan may experience lower economic growth. Lower
economic growth may lead to decreased standards of living within the country.
Thus, this macroeconomic objective would not be achieved.
On the other hand, one macroeconomic objective is to maintain a low
unemployment rate, but an improvement in a country’s terms of trade may
clash with this aim. As previously explained, a fall in net trade, as a result of
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