If inflation in Australia is higher than inflation in other countries, what will be the effect on net exports for Australia, ceteris paribus?

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Question restatement: If inflation in Australia is higher than inflation in other countries, what will be the effect on net exports for Australia, ceteris paribus?

Option a: Net exports will rise as Australian exports increase. This would require Australian exports to become more competitive or in higher demand, which is unlikely given higher domestic inflation makes Australian goods more expensive relative to foreign goods. So this reasoning contradicts the expected impact of higher inflation on price competitiveness, making this option incorrect.

Option b: Net exports will decrease as Australian exports decrease. When domestic inflation is higher than abroad, Australian goods and services become relatively more expensive for foreign buyers, reducing demand for Australian exports. At the same time, if inflation raises the price of domestic inputs or the currency, it can also influence export competitiveness downward. This aligns with the standard open-economy intuition that higher relative inflation tends to reduce net exports via a drop in exports (and potentially a rise in imports if foreign goods become relatively cheaper). The stated reasoning here captures the plausible mechanism behind a fall in net exports due to decreased exports under higher relative inflation, making this option a plausible correct interpretation.

Option c: Net exports will decrease as Australian imports decrease. This statement asserts that a fall in imports drives down net exports, but net exports are exports minus imports. A decrease in imports would tend to increase net exports if imports fall while exports stay constant. Since the premise focuses on higher inflation in Australia relative to other countries leading to weaker exports rather than weaker imports, this option misstates the direction of the relationship. Therefore, this option is incorrect.

Option d: Net exports will rise as Australian imports decrease. While a decrease in imports would indeed increase net exports if exports remain the same, the causal link provided by higher inflation is more commonly associated with reduced export competitiveness (and not clearly with reduced imports). Since the question centers on relative inflation effects on exports first and foremost, this option attributes the net export change to imports alone and contradicts the typical mechanism described in the scenario, making it incorrect.

Overall, the reasoning hinges on how higher domestic inflation relative to trading partners affects relative prices and competitiveness. Higher inflation tends to raise the price of Australian goods abroad, dampening demand for exports, which tends to reduce net exports. The option that states net exports decrease as Australian exports decrease aligns with this mechanism, while the others mischaracterize the direction of the effect or rely on less likely causal pathways.

MCD2090 Macroeconomics - Trimester 2 - 2025

If inflation in Australia is higher than inflation in other countries, what will be the effect on net exports for Australia, ceteris paribus?

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