LS5, LS6 - Patterns Of Trade, Terms Of Trade Flashcards
Pattern of trade
Nature of trade (imports and exports) between 2 countries, and how it changes over time
Comparative advantage
Over time, a country’s natural resources, wage costs, infrastructure, non-price factors (innovation), import controls and ex rate changes, leading to a change in comparative advantage
This will lead to a change in the comp of different industries, resulting in a change in demand for exports as people switch to firms that aren most comp - pattern of trade changes
Ex: UK used to be major steel producer, but comp adv has shifted to other sectors (services, finance etc) so pattern of trade has changed
Emerging economy
Economy that is progressing towards becoming more advanced, by means of rapid growth and industrialisation
Emerging economies cause both pattern of trade and size of trade flows to change - they might have more skilled labour, larger workforces, newer and improved infrastructure/manufacturing processes that make it more competitive compared to other economies
Changes in exchange rate
Changes in relative ex rates can change export/import comp
Lower ex rate relative to other economy - exports from country A become cheaper for country B, imports from B to A more expensive - increase in export comp
Terms of trade and how is it calculated
Terms of trade- an index that shows the value of a country’s average export prices relative to their average import prices. It’s an indicator of the level of imports a given basket of exports can buy calculated using this equation:
Terms of trade= index of average export prices/ index of average import prices *100
The terms of trade can worsen if export prices fall or if import prices rise; the terms of trade can also improve if export prices rise or if import prices fall
Movement in the terms of trades is said to be favourable if the terms of trade increase as the country can buy more imports with the same level of exports.
Factors influencing a countries terms of trade
An improvement in the terms of trade will be caused by a rise in export prices or a fall in import prices. A deterioration will be caused by a fall in export prices or a rise in import prices.
In the short run, exchange rates, inflation and changes in demand/supply of imports or exports affect the terms of trade since these affect the relative prices of imports and exports.
In the long run, an improvement in productivity compared to a country’s main trading partners will decrease the terms of trade since export prices will fall relative to import prices. This can be caused by new technology, more efficient labour etc.
Another long run factor is changing incomes. This affects the pattern of demand for goods and services. For example, a rise in world income causes a rise in demand for tourism and so a country with a strong tourist industry, such as Spain, may see a rise in prices in that industry and hence an increase in their terms of trade. The PrebischSinger hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods, which means those dependent on primary exports will see a fall in their terms of trade.
In general, anything which affects the price of a country’s imports or exports will affect its terms of trade
Reasons for a deterioration in the terms of trade
A weak exchange rate- this could be because of the currency is increasing as the nation is purchasing more imports. Consequently, the price of imports increases whilst the price of exports decreases worsening the terms of trade- more exports need to be sold to purchase the same level of imports.
An improvement in international competitiveness- could be because of a fall inflation, rise in productivity, tech. export prices will fall relative to import prices, worsening terms of trade Lower demand for a nation’s exports- could be because of falling incomes abroad as economies of major trading partners in recession- export prices will fall relative to import prices worsening the terms of trade
If world incomes are rising but a country is specialising in the production and export of primary commodities whilst importing capital or manufactured goods. Demand for primary commodities is income inelastic whilst demand for manufactured goods is income elastic. Consequently, world incomes would rise, demand and thus prices for manu goods will rise faster than demand and prices for primary commodities worsening the terms of trade for such a country; prebisch- singer hypothesis
Reasons for improvement in terms of trade
A strong exchange rate
A worsening in international competitiveness
Higher demand for a nations export- could be because of rising incomes abroad as economies of major trading partners boom. Export prices will rise relative improving terms of trade
Impacts of an improvement/deterioration in terms of trade
If PED of exports and imports is inelastic, a favourable movement in terms of trade would improve the CA on the balance of payments whilst if it is elastic, a favourable movement would worsen the CA.
An improvement in the terms of trade - fall in GDP and a rise in U/E, if it is caused by a rise in export prices, exports will fall and if it is caused by a fall in import prices, imports will rise- A reduction in production within the country = fall in jobs and output. However, a long-term decline in the terms of trade suggests a long-term decline in SOL as less imports can be bought.
Cause of the change. If an improvement has occurred due to increased demand for exports, then this will be beneficial for the country. If a deterioration is caused by an improvement in international competitiveness, this will also be beneficial. For an improvement to be beneficial, export revenues must increase.
- A fall in the terms of trade caused by a fall in export prices for a country dependent on primary commodities could reduce AD in the economy- demand for primary commodities is price inelastic - prices fall so do revenue generated from their export for developing countries= economic growth will fall in developing countries reducing incomes and SOL via a fall in gdp
- A fall in the terms of trade could significantly worsen the government budget position. As export prices fall and demand is inelastic, revenues decrease, reducing tax revenue collected from corp tax, income tax and VAT. Consequently, gov will have less revenue to spend on education, healthcare, infrastructure- for the long run performance
- A developing nation likely to experience higher levels of indebtedness. If export prices fall so do revenue- harder to service existing debt.
Is terms of trade good for an economy (evaluate aswell)
DEPENDS…
If due to higher export demand- Higher export demand, improving the terms of trade via higher export prices, beneficial, export revenues increases improving CA position and thus increasing AD
THE price elasticity of demand for exports . Price inelastic demand, export price increases, demand for exports decrease but proportionately less than price increase. Export rev increase increasing CA position and boosting AD. However growing force of globalisation means in reality there are many substitutes available for an importing country. Demand for a country’s exports will be more elastic over time worsening CA position and AD
Factors influencing pattern of trade
Patterns of trade can change significantly over time e.g. up to the 1980s the UK traded predominantly with Commonwealth Countries. In 2020, 46% of trade was with EU countries & 26% was with the USA
Comparative advantage: Countries will trade where there is a comparative advantage to trading. A change in the comparative advantage- affect the trade pattern. There has been a recent growth in the exports of manufactured goods from developing countries to developed countries. Their share of world trade has risen and the volume of manufactured goods that they export has increased. However, since China’s population is now ageing, their wage competitiveness has fallen- due to the rise of the middle class in China, demand higher wages and consume more.
Emerging economies: Countries grow at different rates and when they grow, they are likely to need to import more goods and services than before as well as exporting more to pay for this. Emerging economies shift the trade pattern by taking up a larger proportion of a country’s imports and exports than they had previously. The collapse of communism has meant that more countries, especially developing countries, are participating in world trade.
Trading blocs and bilateral trading agreements: These increase the level of trade between certain countries and so influence the pattern of trade because trade increases between these countries and decreases between others. Joining the EU meant that the UK traded a lot more with European countries than previously, and less with countries outside the EU.
Relative exchange rates: The exchange rate affects the relative prices of goods between countries. A change in price will affect the pattern of trade. It can be argued that the UK’s trade deficit with Europe is due to the strength of the pound. China have kept their currency weak in order to increase their trade surplus by making exports more competitive.
