4.1.4 - Pattern of trade

Question 1

How to calculate terms of trade

Answer 1

(index of export prices/index of import prices) x100

Question 2

Define terms of trade

Answer 2

the terms of trade (also known as the real exchange rate) is the real value of countries exports in terms of their imports. Thus, it is a function of the price levels in the domestic and foreign country and the nominal exchange
rate.

or: an index that tracks the relative price of a country’s exports compared to its imports

Question 3

How to describe TOT

Answer 3

deterioration = TOT smaller
improvement = TOT larger

Question 4

Short run factors affecting TOT

Answer 4

Changes in demand and supply for exports and imports
Changes in inflation rates - high inflation raises x prices and improved tot but acc (EVAL) a decrease in intl comp of x occurs
Changes in exchange rates

Question 5

long run factors affecting TOT

Answer 5

Changes in incomes - A rise in the relative income of a country will lead to a deterioration in the terms of trade. refer to prebisch singer hypothesis

Changes in productivity - A rise in the relative productivity of a country will lead to a deterioration in the terms of trade. but eval: intl comp increases so deterioration good thing in this case

Question 6

How does relative productivity affect TOT

Answer 6

• If productivity is higher in one country relative to other countries, its unit costs will fall relative to these other countries.
• Therefore, the prices of the country’s goods will fall relative to other countries.
• Therefore, the index of export prices will fall relative to the index of import prices

Question 7

General stakeholder effects of improvement in terms of trade

Answer 7

• Improvement in the terms of trade = A rise in export revenue = higher profits for domestic firms
  + Investment - higher funds available for investment  higher spending on capital, higher spending on R & D, more able to train/hire workers
  + Workers - higher employment, higher job security, higher wages
  + Shareholders - higher share prices (wealth effects)

Question 8

Causes in TOT improvement

Answer 8

1. Increase in demand for exports e.g. through higher overseas incomes 2. Decrease in supply of exports e.g. bad weather 3. Increase in relative inflation 4. Appreciation of the exchange rate 5. Fall in relative productivity

note that causes 2-5 cause a fall in export demand but a rise in export prices so overall, the impat of improvement of TOT depends on PED of exports

Question 9

Discuss how PED of exports affects impact and improvement in TOT has

Answer 9

• If exports are price elastic, an improvement in the terms of trade, caused by a rise in export prices, will cause a deterioration in the current account on the balance of payments.
• If exports are price inelastic, an improvement in the terms of trade, caused by a rise in export prices, will cause an improvement in the current account on the balance of payments

Question 10

Discuss how PED of imports affects impact and improvement in TOT has

Answer 10

• If imports are price elastic, a deterioration in the terms of trade, caused by a rise in import prices, will cause an improvement in the current account on the balance of payments.
• If imports are price inelastic, a deterioration in the terms of trade, caused by a rise in import prices, will cause a deterioration in the current account on the balance of payments.

Question 11

impact of TOT on inflation

Answer 11

improvement in TOT caused by falling import prices = fall in domestic inflation

deterioration in TOT caused by rising import prices = domestic inflation raised

Question 12

How to discuss economic impacts of TOT changes

Answer 12

talk about living standard - import prices
current account on BOP
inflation

Question 13

indication of a beneficial improvement in TOT

Answer 13

rising in export revenue - this always occurs when improvement is caused by increased demand for exportd as both export quantity and price rises

Question 14

How does TOT changes impact living standard

Answer 14

• An improvement in the terms of trade is likely to lead to a fall in GDP and a rise
  in unemployment, since if it is caused by a rise in export prices, exports will fall and if
  it is caused by a fall in import prices, imports will rise.
• Both of these causes a reduction in production within the country and so a fall in jobs and output. However, a
  long term decline in the terms of trade suggests a long term decline in living
  standards as less imports can be bought.