International trade

Question 1

Define the terms of trade

Answer 1

the terms of trade measures the price of exports relative to the price of imports. It is therefore the amount of imports that can be bought per unit of exports

Question 2

How do you calculate the index of the TOT

Answer 2

index = index of export prices / index of import prices *100

Question 3

what causes an impovement or a deterioration in a country’s TOT?

Answer 3

if a country’s TOT improves, then its the average price of its exports is increasing relative to the price of its imports

If a country’s TOT worsens, then the average price of its imports is increasing relative to the price of its exports

Question 4

What happens to countries that export a good, where the world price of this good has risen

What happens to countries that import a good, where the world price of this good has risen

Answer 4

countries that export a good - TOT improves

countries that import the good - TOT worsens

Question 5

World price of a good falls

What happens to the TOT of a country exporting this good?

What happens to the TOT of a country importing this good?

Answer 5

exporting country - TOT falls

importing country - TOT rises

Question 6

How does an appreciation in the currency of a country affect its TOT

Answer 6

Appreciation - SPICED - stronger pound imports cheaper, exports dearer, therefore this will improve the terms of trade

Question 7

How does inflation in a country affect its TOT

Answer 7

inflation improves the terms of trade of a country

Question 8

How does an increase in demand for a good affect the TOT for a country exporting the good, and for a country importing the good

Answer 8

country exporting - TOT will improve, because exports will be more expensive if demand rises

country importing - TOT will worsen, because price of good increases, therefore average price of imports will increase.

Question 9

how does a rise in productivity affect the TOT

Answer 9

rising productivity causes lower prices, which in turn, worsens the terms of trade

Question 10

how does changing income affecting global demand, impact TOT

Answer 10

• depends on YED

Question 11

what is the impact of long term improvements to the terms of trade?

Answer 11

Global redistribution of output and income
- if a country’s TOT sees an improvement over the long term, this means that the country can buy more imports with the same number of exports
- this means that the country can spend more on importing capital goods, leading to economic growth, as firms will become more efficient, leading to a rightward shift in the SRAS curve, thus boosting economic growth
- an improvement in the terms of trade can also lead to improved standards of living, because the country will be able to spend more on importing consumer goods

• the gain in extra output corresponds to a loss in output for other countries, which experience deterioriating terms of trade
• they won’t be able to import as many capital or consumer goods, meaning cost of production may increase, and standards of living will see smaller improvements

Question 12

how MIGHT a change to the terms of trade affect the balance of trade

Answer 12

a change in the terms of trade may cause an improvement to the balance of trade if it causes the value of exports to increase, or the value of imports to decrease

Question 13

will an improvement in the terms of trade always lead to an improvement in the balance of trade

Answer 13

NO

Question 14

if the cause of the change in the TOT is because of a change in demand for exports or imports, how does this affect the balance of trade

Answer 14

• if the cause is because of a change in demand, then the TOT and balance of trade will move in the same direction

Question 15

if the cause of the change in the TOT is because of a change in supply for exports or imports, how does this affect the balance of trade

Answer 15

if PEDx or PEDm is less than 1 (inelastic), then the TOT and balance of trade will move in the same direction, i.e. an improvement in TOT causes an improvement in the balance of trade

if PEDx or PEDm is greater than 1 (elastic), then the TOT and the balance of trade will move in opposite directions. (improvement in TOT leads to balance of trade worsening, and vice-versa)

Question 16

describe the prebisch singer hypothesis - how does it suggest that poorer countries don’t benefit from free trade, as they experience a deterioration in their balance of trade

Answer 16

• manufactured goods, when compared with raw unfinished goods, have a greater income elasticity of demand (YED).
• therefore, as income increases, the demand for manufactured goods tends to increase proportionately more than with the raw unfinished goods
• this is because manufactured goods form a greater proportion of the market for luxury goods, than raw materials
• worsens the terms of trade - price of exports / price of imports, because demand for their exports will increase by less than demand for manufactured goods
• price of raw goods declines relative to the price of manufactured goods

2nd reason:
- the PED for raw materials tends to be price inelastic, as they are necessities
- this means that a decrease in price, will cause less of an increase in quantity demanded
- consequently, decreasing price takes away from the total revenue they are making from the raw material
- primary resources also have few substitutes, making them price inelastic
- primary products often face price volatility - inelastic demand and inelastic supply - therefore a decrease in demand can massively affect revenue
- revenue links to national income

Question 17

what is the marshall lerner condition

Answer 17

• the effects of a devaluation will only lead to an improvement in the balance of trade provided that the sum of the price elasticity of demand for exports and imports is >1
• when PEDx +PEDm < 1, a devaluation leads to a deterioration of the balance of trade
• a devaluation makes imports dearer and exports cheaper, therefore it should make exports more competitive, meaning quantity exported increases, and quantity imported decreases, therefore the balance of trade improves
• imports dearer, exports cheaper, means the TOT worsens

Question 18

explain the J curve

Answer 18

at first, a devaluation in currency will cause the balance of trade to worsen, because the price elasticity of demand for exports and imports will be inelastic - stuck in fixed contracts, time lag etc

in the long run, the demand for exports and imports will be more elastic, and the sum will be greater than 1, therefore the devaluation will eventually improve the balance of trade.