3.5 Terms of trade Flashcards
What is the ‘terms of trade’ concept?
A concept that relates the prices that a country receives for its exports to the prices it pays for its imports.
What is the terms of trade equation?
Terms of trade = (average price of imports/average price of exports) x 100
What is meant by an improvement in the terms of trade?
The terms of trade figure increases
What is meant by a deterioration in the terms of trade?
The figure for the terms of trade decreases
What are causes for short term changes in the terms of trade?
(4)
- Changes in global demand
- Change in global supply
- Changes in domestic rate of inflation (relative)
- Changes in exchange rates
What are causes for long term changes in the terms of trade?
(4)
- Long run growth in incomes
- Changes in productivity
- Technological advances
- Trade protection
How does the price elasticity of supply impact the terms of trade?
If exports are PES inelastic in the short run, prices change by more.
There will be a deterioration in the terms of trade, unless the price of imports falls by more.
How does the price elasticity of demand impact the terms of trade?
If exports are price inelastic, and quantity decreases, the terms of trade will improve as long as the price imports don’t increase by more.
How might depreciation impact the terms of trade?
Depreciation causes the relative price of exports to decrease, and the relative price of imports to increase.
If exports are inelastic, the price decreases more than quantity increases.
The terms of trade would worsen unless the PED of imports is elastic and/or Marsher-Lerner is met.
How might appreciation impact the terms of trade?
Appreciation causes the relative price of exports to increase, and the relative price of imports to decrease.
If exports are inelastic, the price increases more than quantity decreases.
The terms of trade would worsen unless the PED of imports is inelastic and/or Marsher-Lerner is not met.
What is the Prebisch-Singer hypothesis?
Suggest that over the long run the price of primary goods (e.g. coal, coffee, and cocoa) decline in proportion to the prices of manufactured goods (e.g. cars and washing machines)
How does the Prebisch-Singer hypothesis relate to terms of trade?
There would be a long-run decline in the terms of trade for countries that depend on exporting primary goods.
YED < YED → world incomes rise
Increase in the price of imports proportionally larger than the increase in the price of exports → terms of trade deteriorate.
Therefore, developing nations should diversify/industrialise.
However, this is only an observation.
What is the Heckscher-Ohlin theory?
A country should specialise in those goods that are intensive in the country’s factor endowment.
The more abundant the factor > the cheaper production > the greater the comparative advantage.
Developing countries should specialise in labour-intensive primary products.
Primary products have a low YED.
Therefore over time, their terms of trade will deteriorate.
