Terms of Trade - ATAR Economics

Terms of Trade (TOT)

\*Measures the ratio of a basket of export prices to a basket of import prices

TOT Index

* Measures movements in the the prices of imports and exports
* TOT links with living std’s

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Changes in TOT

* Improved TOT means more imports can be bought with a given amount of exports, increasing consumption, hence living std’s
* Decreased TOT means less imports can be bought with a given amount of exports, decreasing consumption, decreasing living std’s

Formula

Export Price Index / Import Price Index x 100

Favourable Outcomes

Increase in export prices greater than import prices

Fall in import prices greater than export prices

Unfavourable outcomes

Increase in import prices greater than increase in export prices

fall in export prices greater than fall in import prices

Factors affecting TOT

* Demand and Supply of Imports & Exports
* Changes in inflation
* Changes in exchange rate
* Microeconomic reform

TOT declines

* Living std’s decrease
* a given amount of exports will now buy a smaller quantity of imports

TOT Incline

* Living std’s increase
* A given amount of exports can now buy a larger amount of imports

Impact of favourable movement

* Increase in real income and living std’s
* Trade balance will grow, more earnings from exports rather than imports, BOGS will grow
* Exchange rate (AUD is a commdity currency), cause an appreciation of AUD due to higher demand
* Inflation will be increased due to high national income, investment and spending

Impact of unfavourable movement

* decrease in real income living std’s
* TB will decrease, less earnings from exports rather than imports, bogs will go down
* Excange rate will depreciated due to less demand
* Inflation will decrease due to lower national income, investment, spending