4.1.4 Terms of Trade

Question 1

What are the terms of trade?

Answer 1

• The terms of trade (ToT) measures the relative prices of a country’s exports compared to the cost (prices) of
  imported goods and services.
• Terms of trade is the ratio of the weighted price index for exports to the price index for imports

Question 2

Formula for calculating the terms of trade:

Answer 2

Terms of Trade (ToT) index = (price index for exports) / (price index for imports) x 100

Question 3

What does a rise in the price index for exports mean for the terms of trade?

Answer 3

A rise in the price index for exports of goods and services improves the terms of trade and this means that a
country can buy more imports for any given level of exports.

Question 4

What does an improvement in the terms of trade mean?

Answer 4

An improvement in the terms of trade mean that export prices are rising relative to import prices. Economists say that the ToT has improved when export prices rise because fewer goods have to be exported to buy a certain amount of imports

Question 5

What are the factors influencing terms of trade?

Answer 5

• Global (world) prices for raw materials and components
  o Rising oil prices improve terms of trade for oil exporters
  o Rising gas prices worsen terms of trade for energy importers
• The exchange rate:
  o A stronger currency lowers import prices – leading to improved terms of trade
  o A weaker currency increases import prices – leading to reduced terms of trade
• Import tariffs and other trade barriers such as quotas
  o An import tariff (tax) increases the price of imports, other factors remaining the same, this worsens
  the terms of trade
• Domestic and global inflation rates
• Changing factor endowments

Question 6

Draw a table analysing and evaluating the effects of an improved terms of trade

Answer 6