4.1.4. Terms of trade

Question 1

What is terms of trade?

Answer 1

Refers to the ratio of a country’s average price of exports to country’s average price of imports (Relative price of imports and exports can have direct bearing on standard of living in a country)

Question 2

What can exporting high priced goods result in?

Answer 2

Higher incomes and the ability to buy cheaper imports

Question 3

How do you work out terms of trade?

Answer 3

Index of average export prices/ Index of average import prices
x100

Worked out in same way as CPI with weighted basket of imports and exports

Question 4

Work out terms of trade (slide 5)

Answer 4

Slide 5

Question 5

What factors influence a country’s terms of trade?

Answer 5

1. Inflation rates: if exports are inelastic in demand will improve terms if trade if elastic will worsen
2. Productivity rates: continuous improvements in productivity can lower costs and can be passed as lower prices. Lower prices for exports can deteriorate terms of trade
3. Changes in exchange rates: if prices change then terms of trade between two countries change

Question 6

What are the impacts of changes in terms of trade?

Answer 6

• Changes to current account balance
  -Changes to GDP
  -Changes to unemployment levels
  -Changes to disposable income
  -Changes to standards of living

Question 7

What will likely happen to the terms of trade if the price of exports rise?

Answer 7

Improvement to terms of trade as if PED of exports is inelastic then reduction in QD will be less than increase in price and economy will benefit. This will cause output to increase, unemployment to decrease and standard of living to improve

Question 8

What will likely happen to the terms of trade if the price of imports falls?

Answer 8

Improvement in terms of trade. If PED of imports is elastic then increase in QD will be more than decrease in price and economy will spend more on imports. This will mean more disposable income, standard of living improving, domestic output may fall as foreign consumption increases.

Question 9

What will likely happen to the terms of trade if the price of exports falls?

Answer 9

Deterioration in the terms of trade. This is because if PED of exports is elastic then increase in QD will be more than decrease in price and economy will benefit. This will lead to ouput increasing, unemployment decreasing and standard of living improving

Question 10

What will likely happen to the terms of trade if the price of imports rises?

Answer 10

Causes deterioration in the terms of trade. Where demand for imports is price inelastic, consumers demand goods in similar proportions and thus spend more on imports. This leads to domestic output unlikely to fall, imports decrease slightly and less disposable income so worse standard of living