4.1.4 Terms of trade

terms of trade

ratio of a country’s average price of exports to the country’s average price of imports

how can the relative price of imports and exports impact standard of living within a country

Exporting goods which are highly priced results in higherincomes and the ability to buy cheaper imports

how to calculate terms of trade

how is index for imports and exports created 

same way that a consumer price index is created (using a weighted basket of imports and exports)

which one will be base year

year in which index for both export and import pries is 100

factors influencing a countrys terms of trade

• relative inflation rates

• relative productivity rates

  • changes in exchange rates

  • changes in demand/supply of imports or exports

  • changing incomes

how does relative inflation rates influence a countrys terms of trade

Inflation increases the price of goods/services within a country. This means that their price is now more expensive to the rest of the world. If the exports are price inelastic in demand this will improve the terms of trade, if elastic then it is likely to worsen the terms oftrade

how does relative productivity rates influence a countrys terms of trade

continuous improvements in productivity can lower costs and these can be passed on in the form oflower prices. Lower prices for export products will mean thatthe terms of trade will deteriorate i.e.fewer imports can be bought with one unit of exports

how does changes in exchange rates influence a countrys terms of trade

exchange rates constantly change the price of exports and imports. If prices change then the terms of trade between the two countries change. Specic data would need to be provided in orderto determine ifthe terms oftrade have improved or deteriorated for each trading partner

impacts of changes in terms of trade

• Changes to the current account balance in the Balance of Payments

• Changes to national output(GDP)

• Changes to unemployment levels

• Changes to the level of international competitiveness

• Changes to disposable income

• Changes to standards ofliving

what is the effect of price of inelastic exports rising

• improvement in terms of trade

• If PED of exports is inelastic then the reduction in quantity demanded will be less than the increase in price and the economy will benet

• Outputincreases

• Unemployment decreases

• Standard ofliving improves

what is the effect of price of elastic imports falling

• improvement in terms of trade

• If PED of imports is elastic (necessity)then the increase in quantity demanded will be more than the decrease in price and the economy will spend more on imports

• More disposable income

• Standard ofliving improves

• Domestic output may fall as foreign consumption increases

what is the effect of price of elastic exports falling

• deterioration of terms of trade

• If PED of exports is elastic then the increase in quantity demanded will be more than the decrease in price and the economy will benefit

• Outputincreases

• Unemployment decreases

• Standard ofliving improves

what is the effect of price of inelastic imports rising

• deterioration of terms of trade

• Where demand for imports is price inelastic, consumers would demand the goods in similar proportions and thus spend signicantly more on imports

• Domestic output unlikely to fall

• Imports will decrease slightly

• Less disposable income so worse standard ofliving