Analysis of Terms Of Trade

• Improvements in the terms of trade are not always good for a nation, and deteriorations in the terms of trade are not always bad for a nation
• The terms of trade equation implies that improvements are always good and deteriorations are always bad, but this is a flawed assumption
• Improvement in terms of trade due to increased demand for exports

  1. Increase in export price

  2. Quantity of exports remains the same

  3. Increase in export revenue
• Increase in export revenue due to improvement in terms of trade is a good thing for the nation
• Improvement in terms of trade due to high relative inflation rates

  1. Increase in export prices

  2. Need to consider elasticity of demand for exports
• Elastic demand for exports

  As export prices increase, export revenue decreases
• Inelastic demand for exports


  As export prices increase, export revenue increases
• The terms of trade equation assumes quantity of exports remains the same, which is a flawed assumption
• Need to consider changes in export quantities and elasticity of demand to determine impact of terms of trade changes
• Deterioration in terms of trade is not always bad - it could be due to increased productivity and competitiveness, leading to higher export quantities and revenues
• For developing countries, deterioration in terms of trade can be bad due to the Prebisch-Singer hypothesis
• The terms of trade metric ignores important factors like changes in export/import quantities and elasticities, which are crucial in determining the impact on the economy
• Focusing only on terms of trade changes, without considering changes in revenues and expenditures, can lead to incorrect conclusions about the impact on the economy