Terms of Trade

Question 1

Meaning and Measurement of Terms of Trade

Answer 1

The terms of trade measures the price of exports received vs the price of imports paid.

It’s a ratio of export prices to import prices

TOT = (export price index / import price index) * 100

Question 2

Factors that may affect the Terms of Trade

Answer 2

1. Commodity prices
2. Production costs in trading partners
3. Exchange Rates (check exchange rate flashcards)
4. others

Question 3

Effects of Commodity Prices (exports)

Answer 3

This is the main driver of the ToT in Australia.

Commodity prices fluctuate on world markets.

For example: Higher demand for coal, would increase its price to increase. This means that we’re receiving more money from exporting coal, leading to an improvement in our terms of trade.

Question 4

Effects of Cost of Production in Trading Partners (import)

Answer 4

• If costs of production increase in one of our trading partners, the prices paid for our imported goods will increase too and thus decrease ToT.
• A decrease in costs of production will reduce the prices paid for imports and increase the ToT.