econ dal terms of trade Flashcards
what is the terms of trade equation?
index of export prices/ index of import prices
times 100
what is the terms of trade?
the relationship between a countries export prices and its import prices
when do we have an improvement and a deterioration on the terms of trade? what does it mean in terms of imports?
improvement if the number increases (we can buy more imports)
deterioration if it decreases (we can buy less imports than before)
what happened for the terms of trade to improve?
improvement = we can buy more imports
the price for exports increased
or
the price of imports decreased
what happened for the terms of trade to deterioration?
deterioration = we can buy less imports
the price for exports decreased
or
the price of imports increased
what factors can change the figure of the terms of trade? short run factors
- change in demand and supply for export/imports
- relative inflation rates - high inflation = higher price exports improves the terms of trade (we can import more) BUT reduces competitiveness
- changes in the exchange rate
what factors can change the figure of the terms of trade? long run factors
- incomes
- productivity - lowers cost of production —> lower prices
- technology - lowers cost of production —> lower prices
when we have an improvement in the terms of trade what do we need for it to be beneficial?
if there is an increase in demand for our good leading to higher REVENUE
what are causes of improvements in the terms of trade?
- increased demand for exports
- appreciating currency - imports become cheaper —> choice —> higher living standards
- lower inflation compared to competition
what are causes of deterioration in the terms of trade?
- fall in demand for exports
- depreciation of currency - imports become more expensive
- high inflation compared to competition
the for and against an improvement in the terms of trade
for =
1. higher purchasing power - can buy more imports - improves living standards
2. low imported inflation - import prices are falling due to the stronger currency - costs fall
3. increased real income - the same amount of exports can buy more - boosts consumer spending power
against =
1. reduced competitiveness - high export prices make them less attractive - reduces demand - especially if export PED is elastic
2. deindustrialisation risk - may worsen the current account over time if exports fall - could lead to dutch disease
3. overreliance on improvements caused by external factors
the for and against a deterioration in the terms of trade
for =
1. improve price competitiveness - if export prices fall or import prices rise domestic goods look cheaper globally - may boost export volumes
2. boost to domestic industries - more demand for local goods and services - jobs - industry expansion
3. helps correct a current account deficit - especially if demand is elastic
against =
1. lowers real incomes - need to export more to afford the same amount of imports - bad for living standards
2. imported inflation - import prices rise
- costs increase
3. debt pressures - a country is reliant on imported goods then rising import prices worsens the debt burden
