4.1.4- terms of trade

• What does the terms of trade measure in international trade?

  The rate of exchange of one product for another between two countries

  
• How is the terms of trade calculated?

  By comparing the ratio of export prices to import prices

  
• What does the terms of trade capture regarding a country's economy?

  It captures the impact of relative prices on competitiveness and living standards

  
• What does a rising terms of trade indicate?

  Export prices increase while import prices fall

  
• What happens when the terms of trade fall?

  Export prices decrease while import prices rise

  
• How does a rise in export prices relative to import prices affect living standards?

  It improves living standards as imported goods become cheaper
• What is the effect of rising import prices relative to export prices on living standards?

  It leads to a decline in living standards as imports become more expensive
• Why do developing countries often suffer from declining terms of trade?

  They specialize in primary products with low income elasticity of demand (YED)
• What is the impact of currency depreciation on terms of trade?

  It results in an increase in import prices and a deterioration in terms of trade

  
• How does currency appreciation affect terms of trade?

  It makes imports cheaper and improves terms of trade

  
• What are the short-run factors influencing terms of trade?

  • Exchange rate changes
  • Inflation rates
  • Changes in demand for exports/imports
  • Changing commodity prices

  
• What are the long-run factors influencing terms of trade?

  • Productivity improvements
  • Changes in incomes affecting demand

  
• How do changes in terms of trade impact living standards?

  They affect the competitiveness of goods and services, impacting the balance of payments
• What is the effect of improved terms of trade on living standards?

  Higher living standards as the country exports less to afford imports

  
• What happens to the current account on the balance of payments with improved terms of trade?

  It may deteriorate due to less competitiveness from rising export prices
• How do price elasticities affect the impact of changes in terms of trade on the current account?

  • Exports price elastic: improvement in TOT, worsening current account
  • Exports price inelastic: improvement in both TOT and current account
  • Imports price elastic: deterioration in TOT, improvement in current account
  • Imports price inelastic: deterioration in both TOT and current account
• Why did the UK terms of trade not deteriorate as expected in 2008?

  Demand for UK exports was relatively inelastic, leading to higher prices
• What effect did the weaker Pound have on UK exporters in 2008?

  It encouraged exporters to increase profit margins and prices
• How did the profitability of exports affect supply in the UK market?

  Higher profitability did not encourage more firms to enter the market immediately
• What happens when exporters set prices in fixed foreign currency?

  A depreciation in the exchange rate leads to a higher sterling price
• What was the impact of world prices after the crisis on the UK terms of trade?

  Falling import prices offset lower export prices