4.1.4 Terms of trade Flashcards
What is a country’s terms of trade?
The ratio of a country’s average price of exports compared to the country’s average price of imports.
Calculation of terms of trade
Short term Factors influencing a country’s terms of trade
- Relative inflation rates
- Changes in exchange rates
- Change in demand for exports or imports
Long term factors that influence a country’s terms of trade.
- Rise in relative productivity
- Changes in income.
How do relative inflation rates influence a country’s terms of trade?
Inflation increases the price of goods/services within a country. This means that their price is now more expensive to the rest 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.
How do relative productivity rates influence a country’s terms of trade?
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
How do changes in exchange rates influence a country’s terms of trade?
Exchange rates constantly change the price of exports & imports. If prices change then the terms of trade between the two countries change. A rise in exchange rate is likely yo lead to fall in the price of imported goods.
Impact of Changes in the Terms of Trade
- 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
How does an Improvements in terms of trade affect living standards
- Exports more expensive
- Imports cheaper
- living standards will improve if PED is elastic.
How does a deterioration in terms of trade affect living standards
- Exports are cheaper
- Imports more expensive
- Fall in living standards if PED is relatively elastic.
Explain an economic effect of an improvement in terms of trade
If the terms of trade have improved because of higher prices for a country’s main export, this may stimulate an expansion of GDP growth through increased exports and investment.
For example, exporters of iron ore from Australia will make higher abnormal profits when the world price has risen.
This may lead to a positive accelerator effect on investment.
Another economic effect of an improvement in terms of trade
The terms of trade may also have improved because of a fall in import tariffs which (other factors remaining constant) cause the domestic price of imports to drop.
A possible effect of lower import prices is less cost-push inflation which lifts the profits of businesses such as car makers who import many component parts.
