4.1.4 Terms of trade

Terms of Trade Definition

The ratio of the price index for exports of goods and services to the price index for imports.

Terms of Trade Formula

(Price index for exports of goods and services) / (Price index for imports of goods and services)

Practical Meaning of Terms of Trade

The amount of imports that can be bought with one unit of export.

Effect of Rising Export Price Index

Improves the terms of trade, which is generally a positive development.

Three Causes of an Increase in Terms of Trade

1. Import prices decrease, 2. Export prices increase, 3. Or both.

Trade-off of Increasing Terms of Trade

You can buy more imports per export unit, but the country becomes less internationally competitive.

Impact of Terms of Trade on Balance of Payments

Ceteris paribus positive due to higher export revenue, but less competitiveness can ultimately reduce sales revenue.

Primary Use of Terms of Trade Metric

To measure a country's trade competitiveness relative to other countries.