4.1.4- Terms Of Trade Flashcards
What is terms of trade?
The rate of exchange of one product for another when two countries trade
What does it mean if terms of trade improves?
The county can buy more imports with the same level of output
How is terms of trade calculated?
Index of export prices/ index of import prices x 100
What are the factors affecting terms of trade?
-a rise/fall in export or import prices
-inflation
-changes in demand
-improvement in productivity
-changing incomes
-rise in exchange rate
Why does inflation affect TOT?
TOT increases when inflation is high as exports will be more expensive
Why does changes in demand affect TOT?
Demand may fall due to global creative destruction so prices will fall therefore TOT will deteriorate
Why does improvement in productivity affect TOT?
Causes prices to fall so TOT deteriorates
Why does changing incomes affect TOT?
Causes demand to rise so prices rise so TOT improves
What is the Prebisch-Singer hypothesis?
It says that the long run price of primary goods declines in proportion to manufactured goods so those dependent on primary exports will see a fall in their terms of trade
Why does a rise in the exchange rate affect TOT?
Appreciation means imports are cheaper so TOT improves
How does terms of trade impact PED?
-if elastic, an improvement in TOT would worsen the current account
-if inelastic an improvement in TOT would improve the current account
How does terms of trade impact GDP and employment?
-a rise in TOT will mean export prices rise so demand falls so fall in output and jobs
-however a long term decline in TOT suggests a long term decline in living standards as less imports can be bought
