Theme 4.1.4

Question 1

Define terms of trade

Answer 1

a measure of the relationship between the price of exports relative to the price of imports

Question 2

Terms of Trade

Answer 2

If the price of exports increases by a higher percentage than the price of imports this is referred to as an improvement in the terms of trade as it means that selling the same amount of exports will enable you to purchase a greater amount of imports.
A deterioration in the terms of trade occurs when the price of imports rises relative to the price of imports.

Question 3

Factors influencing a country’s terms of trade

Answer 3

Relative rates of inflation. If domestic inflation is higher than that being experienced abroad then this will inevitably lead to an improvement in a countries terms of trade as the price of UK exports is rising more quickly than the price of Imports. This is not necessarily a good thing however as it means we will sell less abroad which will have an adverse effect on the UK Balance of Payments position.

• If productivity gains are greater in the UK than abroad this will cause average costs per unit to fall more quickly. If this is reflected in a fall in domestic prices compared to goods produced abroad then this will lead to change in the terms of trade.
However, it is important to remember that UK exports are more competitive and should therefore lead to an improvement in the Balance of Payments!

Exchange rates. An appreciation in the value of the pound will effectively increase the price of UK exports and decrease the price of imports leading to an improvement in the terms of trade. A depreciation would have the reverse effect.

Question 4

Impacts of a change in a country’s terms of trade

Answer 4

An improvement in a countries terms of trade will mean that selling the same volume of exports will enable it to finance the purchase of a greater amount of imports or will enable it to purchase the same amount of imports by selling a smaller volume of exports.

Conversely, a deterioration in a countries terms of trade will mean it will need to sell more exports to finance the purchase of the same volume of imports or will mean that selling the same amount of exports will now be mean the purchase of less imports.