4.1.4 Terms Of Trade Flashcards
Define terms of trade
Measures the relative price of exports to imports in an economy
Terms of trade formula
Index of export prices/index of import prices x 100
What is the difference between terms of trade and balance of trade?
- Terms of trade: price
- Balance of trade: difference between the total value of exports compared to the total value of imports
What is an improving terms of trade?
When the price of exports sold overseas increases relative to imports
What is a deteriorating terms of trade?
When the price of exports decreases relative to imports
Reasons that causes terms of trade to improve
- specialisation in higher value exports
- world real income levels change in favour of this country’s exports
- exchange rate appreciates causing import prices to fall
- fall in the world price of imported tech
- reduced protectionism
How does specialisation cause terms of trade to improve?
- a country might switch their production & investment to higher value export
- adding value locally/move up the value chain
How might world real income levels causes terms of trade to improve?
- rising global incomes (income elastic) so the world economy wants more of the things you’re producing
How might exchange rate cause the terms of trade to improve?
Exchange rate has gone up = cost of imports to go down
How might a fall in world price of imported tech cause terms of trade to improve?
Imported tech price decrease = decrease cost
How might reduced protectionism cause terms of trade to improve?
Trade deals with a country which lowers import tariffs or increase import quotas
Reasons that causes terms of trade to worsen
- greater global competition
- tech advances
- global economy downturn/recession
- exchange rate depreciation
- imposition of tariffs
How might greater global competition cause the terms of trade to worsen?
Increase in countries producing same good which decrease the world price of exports
How might tech advances cause terms of trade to worsen?
Reduces the cost of production so price of exports decrease
How might global economy recession cause terms of trade to worsen?
World income levels change to the detriment of this country’s exports = decreased demand = decreased exports
How might exchange rate depreciation cause terms of trade to worsen?
This increases the price of country’s imports
How might imposition of tariffs cause terms of trade to worsen ?
Increase the price of imports e.g essential raw materials
What is an implication of a fall in the terms of trade
Fall in the terms of trade means a country must export more g/s maintain the same level of imports
Evaluation of an implication of a fall in the terms of trade
If caused by a depreciation in exchange rate = improvement in price competitiveness of export = more jobs =more output
Implication of a fall in the terms of trade (evaluation of evaluation)
But if caused by a fall in a country’s export prices, this could lead to a worsening trade balance & lower tax revenue
Implication of a fall in the terms of trade (example 1)
- UK has a stable terms of trade since 2000-8
- However AUS improved during 2009,-10 due to increased high world price of coal & iron ore (key exports)
- also AUS dollar were really expensive = decreased import prices
Implication of a fall in the terms of trade (example 2)
Zambia has volatile terms of trade since they’re a big exporter of copper which has a volatile world price
- evaluation: consider elasticities, inflation and productivity
What is a good reason to improve terms of trade?
If PED for X is price inelastic (average prices up = increased revenue)
Why might a country not want to improve their terms of trade?
- domestic inflation drives up domestic prices relative to import prices
- if PED for X is price elastic (price decrease = revenue decreases)
Benefits of a deterioration in the terms of trade
- greater productivity & efficiency of domestic production
- import price level rise but the PED for M is price elastic (overall spending on imports falls)
- price level (inflation) is rising faster in competitor countries
Good reasons for a deterioration in the terms of trade (greater productivity & efficiency)
- greater productivity & efficiency of domestic production = lower export prices while maintaining profit margins (greater global competitiveness)
Why might an increasing terms of trade be good?
Increased living standards since less has to be exported to buy a given quantity of imports
Why might an increasing terms of trade be bad?
It could mean that the country’ g/s are less competitive & so result in a deterioration in current account, lower output & high unemployment
Is terms of trade increasing good (conclusion)?
The more diversified the economy, the less volatile the terms of trade
Why might an increasing terms of trade be good? (evaluation)
- The Marshall Lerner condition
- = the lower the prices of exports in total money terms rise > than the neg impact of the higher priced imports (Export boost > import negative)
What is the impact of depreciation on macroeconomic objectives?
- current account trade balance
- sustained GDP growth
How can a depreciation lead to sustained GDP growth?
- a depreciation = economy open to international trade & investment = increase AD
- e.g UK 2016, the fall in sterling helped avoid the full-blow on recession
- it can act a shock absorber when a country experiences unexpected turbulence
What happened when UK saw a depreciation
- In the summer of 2016, the fall in sterling helped the UK to avoid the full-blown recession that some analysts had predicted.
- Growth slowed but remained +ve and the weaker pound injected extra demand in industries e.g tourism & transport.
- Manufacturing was assisted with a more competitive exchange rate although this sector accounts for only ten percent of total UK GDP.
Evaluation of a depreciation leading to economic growth in the UK
- there is no guarantee that exporting firms will take advantage of additional competitiveness
- there is evidence that UK firms have instead opted to raise the price o exports = enjoy a higher profit margin
- also imports = more expensive
