4.1.4 Terms Of Trade

Question 1

Define terms of trade

Answer 1

Measures the relative price of exports to imports in an economy

Question 2

Terms of trade formula

Answer 2

Index of export prices/index of import prices x 100

Question 3

What is the difference between terms of trade and balance of trade?

Answer 3

• Terms of trade: price
• Balance of trade: difference between the total value of exports compared to the total value of imports

Question 4

What is an improving terms of trade?

Answer 4

When the price of exports sold overseas increases relative to imports

Question 5

What is a deteriorating terms of trade?

Answer 5

When the price of exports decreases relative to imports

Question 6

Reasons that causes terms of trade to improve

Answer 6

• 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

Question 7

How does specialisation cause terms of trade to improve?

Answer 7

• a country might switch their production & investment to higher value export
• adding value locally/move up the value chain

Question 8

How might world real income levels causes terms of trade to improve?

Answer 8

• rising global incomes (income elastic) so the world economy wants more of the things you’re producing

Question 9

How might exchange rate cause the terms of trade to improve?

Answer 9

Exchange rate has gone up = cost of imports to go down

Question 10

How might a fall in world price of imported tech cause terms of trade to improve?

Answer 10

Imported tech price decrease = decrease cost

Question 11

How might reduced protectionism cause terms of trade to improve?

Answer 11

Trade deals with a country which lowers import tariffs or increase import quotas

Question 12

Reasons that causes terms of trade to worsen

Answer 12

• greater global competition
• tech advances
• global economy downturn/recession
• exchange rate depreciation
• imposition of tariffs

Question 13

How might greater global competition cause the terms of trade to worsen?

Answer 13

Increase in countries producing same good which decrease the world price of exports

Question 14

How might tech advances cause terms of trade to worsen?

Answer 14

Reduces the cost of production so price of exports decrease

Question 15

How might global economy recession cause terms of trade to worsen?

Answer 15

World income levels change to the detriment of this country’s exports = decreased demand = decreased exports

Question 16

How might exchange rate depreciation cause terms of trade to worsen?

Answer 16

This increases the price of country’s imports

Question 17

How might imposition of tariffs cause terms of trade to worsen ?

Answer 17

Increase the price of imports e.g essential raw materials

Question 18

What is an implication of a fall in the terms of trade

Answer 18

Fall in the terms of trade means a country must export more g/s maintain the same level of imports

Question 19

Evaluation of an implication of a fall in the terms of trade

Answer 19

If caused by a depreciation in exchange rate = improvement in price competitiveness of export = more jobs =more output

Question 20

Implication of a fall in the terms of trade (evaluation of evaluation)

Answer 20

But if caused by a fall in a country’s export prices, this could lead to a worsening trade balance & lower tax revenue

Question 21

Implication of a fall in the terms of trade (example 1)

Answer 21

• 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

Question 22

Implication of a fall in the terms of trade (example 2)

Answer 22

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

Question 23

What is a good reason to improve terms of trade?

Answer 23

If PED for X is price inelastic (average prices up = increased revenue)

Question 24

Why might a country not want to improve their terms of trade?

Answer 24

• domestic inflation drives up domestic prices relative to import prices
• if PED for X is price elastic (price decrease = revenue decreases)

Question 25

Benefits of a deterioration in the terms of trade

Answer 25

- 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

Question 26

Good reasons for a deterioration in the terms of trade (greater productivity & efficiency)

Answer 26

- greater productivity & efficiency of domestic production = lower export prices while maintaining profit margins (greater global competitiveness)

Question 27

Why might an increasing terms of trade be good?

Answer 27

Increased living standards since less has to be exported to buy a given quantity of imports

Question 28

Why might an increasing terms of trade be bad?

Answer 28

It could mean that the country’ g/s are less competitive & so result in a deterioration in current account, lower output & high unemployment

Question 29

Is terms of trade increasing good (conclusion)?

Answer 29

The more diversified the economy, the less volatile the terms of trade

Question 30

Why might an increasing terms of trade be good? (evaluation)

Answer 30

- 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)

Question 31

What is the impact of depreciation on macroeconomic objectives?

Answer 31

- current account trade balance - sustained GDP growth

Question 32

How can a depreciation lead to sustained GDP growth?

Answer 32

- 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

Question 33

What happened when UK saw a depreciation

Answer 33

- 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.

Question 34

Evaluation of a depreciation leading to economic growth in the UK

Answer 34

- 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