ChainWhat it assumes · how to break it
Start
World prices of copper rise sharply because of strong demand from China, benefiting a copper exporter such as Zambia.
1
As a result, export revenue rises, because the country receives more for each tonne it sells.
export revenue
export revenue
Assumes: Export volumes do not fall when the price rises.
But: If the price rise is caused by a supply disruption at home, the country has less to sell.
2
This means net exports, a component of AD, increase, and the extra income is spent through the multiplier.
aggregate demand · multiplier
aggregate demand · multiplier
Assumes: The extra revenue is spent in the domestic economy.
But: Where mines are foreign-owned, much of the extra profit is repatriated, so little reaches local spending.
3
At the same time, the terms of trade improve, so each unit of exports buys more imports, including capital goods.
terms of trade
terms of trade
Assumes: The country uses the extra purchasing power to import capital goods.
But: The windfall may be spent on imported consumer goods that add nothing to capacity.
4
Therefore, real GDP rises in the short run, and if the windfall is invested, LRAS shifts right and growth can be sustained.
economic growth · investment
economic growth · investment
Best link to attack
Assumes: Commodity prices stay high long enough for the investment to pay off.
Assumes: Commodity prices stay high long enough for the investment to pay off.
But: Commodity prices are volatile, so a boom is often followed by a slump that reverses the gain and leaves half-finished projects.
End
Economic growth rises in the short run through higher export revenue, and in the long run only if the windfall is invested.
Evaluation chain
- E1However, whether the boost to growth lasts depends on how long commodity prices stay high.
- E2Because demand and supply of primary products are price inelastic in the short run, small shifts in world demand cause large swings in price.
- E3As a result, a boom can turn into a slump within a few years, cutting export revenue and AD just as quickly as they rose.
- E4So a commodity price rise gives a strong but often temporary boost to growth, and lasting growth requires the windfall to be saved or invested in other sectors.
Another way to attack it: Dutch disease can offset the gain: the currency appreciates and other exports and manufacturing shrink, so growth becomes more dependent on one commodity.
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Questions this answers
- Assess the impact of a rise in commodity prices on economic growth in a primary-exporting country.
- Discuss whether reliance on primary product exports is a barrier to growth.
- Explain how an improvement in the terms of trade can raise growth.
Diagram
AD/AS: AD shifts right as net exports rise; if the windfall is invested, LRAS also shifts right. A commodity market diagram with demand shifting right explains the price rise.
Reverse and related
Fall in commodity prices → export revenue and the terms of trade fall, AD falls and growth slows, possibly into recession.