Terms of Trade 4.1

Question 1

Terms of trade def.

Answer 1

measures how a country’s export prices are changing compared to its import prices

Question 2

Factors Influencing a Country’s Terms of Trade

4

Answer 2

Change in the exchange rate

Change in the exchange rate

Changes in demand or supply for imports or exports

Changes in relative productivity

Question 3

Change in the exchange rate

Answer 3

Appreciation results in increased export prices and decreased imports

Question 4

Change in the relative rate of inflation

Answer 4

If domestic inflation inflates faster than trading partners, export prices will rise faster than import prices

Question 5

Changes in relative productivity

Answer 5

If a country has a faster rate of productivity growth than its trading partners, it will have falling costs of production, thus exports will fall in price in relation to imports –> worsening of terms of trade

Question 6

Calculation of the Terms of Trade

Answer 6

Base Year is selected.
TTI = Terms of Trade Index
TTI = (Index of Export Prices / Index of Import Prices) x 100

Question 7

Impact of Changes in a Country’s Terms of Trade

Answer 7

Living standards - Improvement in TTI = country can buy a greater quantity o imports for any given quantity of exports e.g. Middle East

Impact on the balance of payments - can improve or worsen BoP, depending on why ToT improved. If export prices rise due to increased demand, current account may improve. But if it is due to increasing costs of production current account may worsen due to lower competitivity

Impact on inflation - Improvement in ToT results in lower inflation (as import prices decrease)