Factsheet: Terms of trade

Question 1

Terms of Trade

Answer 1

Measure of a country’s export prices relative to it’s import prices.

Price of exports/ Price of imports.

The inverse of the real exchange rate:

P/eP* = 1/Q

Question 2

Import and Export assumptions

Answer 2

Home cost pricing: exports are assumed to be priced identically to the same goods at home, so Px = P.

Imports are assumed to be priced identically to the same foreign goods. Pm = eP*

Question 3

Terms of Trade improvements

Answer 3

An appreciation (fall in e and Q) leads to an improvement in the terms of trade, bc e is on the denominator.

A depreciation (rise in e and Q), will lead to a fall in the terms of trade, because fewer imports can be bought.

Question 4

Terms of trade and price competitiveness

Answer 4

Inverse relationship.

A rise in Q will lead to a deterioration of the terms of trade, but an improvement in price competitiveness.

A fall in Q will lead to an appreciation of the terms of trade, but a decline in price competitiveness.