Terms of Trade Flashcards
(13 cards)
Define terms of trade
The ratio between average export prices and average import prices
Give the calculation for terms of trade
Index of terms of trade = (index of export prices/index of import prices) x 100
Items that contribute a greater value towards imports or exports are given a greater weighting
What do terms of trade tell us?
The value of exports that need to be sold to purchase a given level of imports - particularly relevant to developing economies if they rely on export revenues to purchase manufactured goods
What does an improvement in a country’s terms of trade mean? What might cause an improvement?
The ‘basket’ of exports can purchase more imports than it could before
An improvement is measured by an increase in its index of terms of trade
Requires a rise in the price of the ‘basket’ of exports or a fall in the price of the ‘basket’ of imports
What short run factors influence a country’s ToT?
Demand and supply of imports and exports
Inflation
Exchange rates
How does demand and supply of imports and exports influence a country’s ToT?
A rise in demand for the goods or services from a particular country is likely to increase the price of these items – this would improve the terms of trade for this country
The more significant the product to the country the more significant to terms of trade changes in demand and supply will be
How does inflation influence a country’s ToT?
A rise in domestic inflation relative to trading partners’ inflation will improve a country’s terms of trade
THIS LEADS TO WORSENED COMPETITIVENESS: IMPROVEMENTS IN TOT ARE NOT ALWAYS GOOD FOR THE ECONOMY
The price of exported goods is rising compared to the price of imported goods – so the index of terms of trade will increase
How does the exchange rate influence a country’s ToT?
A strengthening of domestic currency (SPICED) will improve the terms of trade
It makes the price of imports relatively cheaper and the price of exports relatively more expensive
What long run factors influence a country’s ToT?
Technology
Incomes
Productivity
How does technology affect a country’s ToT?
Worsened ToT
Should lower production costs, so the price of exports falls
How do incomes affect a country’s ToT?
Sustained rises in global incomes leads to increasing demand for many goods
Primary commodities are relatively income inelastic so the demand for them will not rise significantly
Manufactured goods are more income elastic meaning demand, and therefore price, will rise by a greater amount
Over time the price of the primary commodities loses ground relative to the price of manufactured goods
Over time developing countries may experience a decrease in their terms of trade
How does productivity affect a country’s ToT?
Worsened ToT
An improvement in domestic productivity should lower costs and therefore the prices of exports
What is the impact of changing terms of trade?
An improvement in a country’s ToT means that the ‘basket’ of exports can buy more than it could before, so consumers should see a rise in living standards, since the value of what they export rises compared to the value of what they import
However, whether this is positive or negative depends on the PED of imports and exports and the reason for the change in ToT
