4.1.4 Terms of trade

Question 1

What is a country’s terms of trade?

Answer 1

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

Question 2

Calculation of terms of trade

Answer 2

Question 3

Factors influencing a country’s terms of trade

Answer 3

• Relative inflation rates
• Relative productivity rates
• Changes in exchange rates

Question 4

How do relative inflation rates influence a country’s terms of trade?

Answer 4

Inflation increases the price of goods/services within a country. This means that their price is now more expensive to the erst 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 of trade.

Question 5

How do relative productivity rates influence a country’s terms of trade?

Answer 5

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

Question 6

How do changes in exchange rates influence a country’s terms of trade?

Answer 6

Exchange rates constantly change the price of exports & imports. If prices change then the terms of trade between the two countries change. Specific data would need to be provided in order to determine if the terms of trade have improved or deteriorated for each trading partner.

Question 7

Impact of Changes in the Terms of Trade

Answer 7

• Changes to the current account 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 of living