4.1.4 Terms of trade

• What do terms of trade refer to?

  The ratio between the price of a country's exports and the price of its imports 
• What does favourable terms of trade mean?

  A country can acquire more imports at a given quantity of exports
• What do the terms of trade measure?

  The quantity if imports a country can obtain for a given quantity of exports
• What is the equation for terms of trade?

  Terms of trade = (Index of Export Prices / Index of Import Prices) X 100
• When do terms of trade improve?

  When export prices rise relative to import prices
• When do terms of trade deteriorate?

  When export prices fall relative to import prices
• What factors influence a county's terms of trade?

  • Country’s rate of inflation relative to other countries
  • Country’s productivity relative to that of another county’s
  • Tariffs
  • Country’s exchange rate
• What is the effect of a country's increase in terms of trade?

  • Higher living standards
  • A deterioration in the current account of the balance of payments
• What is the effect of a county's terms of trade deteriorating?

  • Lower living standards
  • An improvement in the current account of the balance of payments
• What factors influence terms of trade in the short run?

  • Exchange rate fluctuations
  • Commodity price changes
  • Supply shocks
  • Demand shocks
• What factors influence the terms of trade in the long run?

  • Economic growth
  • Technological advancement
  • Trade policies
  • Structural changes
  • Investment
  • Education and human capital
• When do terms of trade increase?

  • Specialisation in higher value exports
  • World real income levels change in favour of this country’s exports
  • Exchange rate appreciates casing import prices to fall
  • Fall in the world price of imported technology
  • Trade deals which lower import tariffs or increases import quotas
• When do terms of trade decrease?

  • Increase in countries producing the same good which decreases the world price of exports
  • Technological advances which reduce the cost of production of exports
  • World income levels change to the detriment of the country’s exports
  • A depreciation of the exchange rate which increases the prices of a country's imports
  • Imposition of tariffs which increases the price of imports such as essential raw materials