TERMS OF TRADE

Question 1

terms of trade

Answer 1

ratio of a country’s average price of exports to the country’s average price of imports

Question 2

terms of trade equation

Answer 2

index of av. X price / index of av. M price x 100

Question 3

short run changes in terms of trade

Answer 3

1. demand changes
2. supply changes
3. relative inflation rates
4. changes in the exchange rates

Question 4

long run changes in the terms of trade

Answer 4

1. when global demand is altered by income changes
2. productivity changes
3. monopoly power
4. trade protectionism

Question 5

SR changes-demand changes

Answer 5

all the factors that affect the demand for both X and M can affect their price as a result.

consumers taste for exports may change

other countries may see their incomes rise, increasing demand for your exports= improving your term of trade

Question 6

SR changes-supply changes

Answer 6

if many countries join a market and create a surplus, then a country’s export prices are likely to drop

1980s market for coffee

Question 7

SR changes-relative inflation rates

Answer 7

if a country’s dom APL rise relative to other countries, its terms of trade improves as well

inflation increase P(X)

this improvement will make those exports less attractive and competitive globally

Question 8

SR changes-changes in the exchange rates

Answer 8

appreciation of a nation’s currency leads to an improvement in their terms of trade as their exports are now more expensive
whilst for their trading partners their term of trades has worsened

Question 9

LR changes-when global demand is altered by income changes

Answer 9

as global income is expected to grow over time

the terms of trade for LEDCs will continue to deteriorate

as demand increase for secondary and tertiary products not commodities

Question 10

LR changes- productivity changes

Answer 10

sustained increases in the relative productivity can lower a country’s export prices and drive down its terms of trade

good reason to have deterioration in the terms of trade

terms of trade can ameliorate due to a decrease in productivity because of higher costs like higher wages which increase export prices- bad

Question 11

LR changes-monopoly power

Answer 11

a monopoly or a successfully oligopoly collusion can increase the terms of trade for their countries by having high prices and high exports but worse the terms of trade for countries that import their goods as those countries imports are now more expensive

Question 12

LR changes-trade protectionism

Answer 12

tariffs/quotas increase M prices relative to X prices

• -> shift terms of trade in favour of large protectionist power
• -> drive down terms of trade for others

subsidies

• ->allow rich countries to promote their X and offer effective prices of their agricultural goods
• -> puts downward pressure on the price of those commodities, lowering prices of primary goods of many poorer countries- make up a majority of contry’s X
• -> even X subs tend to drive down the terms of trade for poorer, primary-producing countries

Question 13

terms of trade and the trade balance

Answer 13

trade balance consists of primarily:
export revenues- inflow of money
import expenditure- outflow of money

depends on PED of X and M if trade balance improves or worsens

Question 14

causes for improvements in the terms of trade x4

Answer 14

increase in demand for exports

decrease in supply of exports

domestic inflation raises export prices

changes in the exchange rate

Question 15

causes for improvements in the terms of trade

increase in demand for exports

Answer 15

due to: change in taste and preferences, increased price of a competitors good, rising incomes abroad…

total rev increases+ improve in trade balance

Question 16

causes for improvements in the terms of trade

decrease in supply of exports

Answer 16

decrease supply= increase X price–> improve ToT

effect of total export rev and trade balance depends on PEDx

inelastic demand of country’s exports= improve

Question 17

causes for improvements in the terms of trade

domestic inflation raises export prices

Answer 17

terms of trade improvements caused by inflation improve the trade balance when demand is inelastic
–> price rises do little to discourage export consumption and thus export rev grows

improvements to the terms of trade caused by inflation reduce the trade balance when demand for exports is elastic
–> price discourages X purchase and cause a lowering of export revenue

in theory this should be good news for LEDCs with commodities as exports but in reality there are many available substitutes = keep dom inflation under control

Question 18

causes for improvements in the terms of trade

changes in the exchange rate

Answer 18

depreciation–> decrease ToT–> elastic–> improves T.B
–> inelastic–> worsens T.B

appreciation–> increase ToT–> elastic–> worsens T.B
–> inelastic–> improve T.B

Question 19

short run fluctuations in the terms of trade

commodity booms

Answer 19

LDC are tied to primary goods and commodities

‘commodity booms’

in a country can cause sudden increase in a country’s terms of trade 2000-2008

–> china and india once they began to fully exploit their domestic resources, they increasingly sought to import more commodity goods= increase demand

Question 20

short run fluctuations in the terms of trade

commodity speculation + interrelated nature of food and fuel

Answer 20

commodity speculation + interrelated nature of food and fuel= increased the price of X commodities

–> >D for food= > fertilisers (made from oil products)

–> increases demand for oil= increases price of oil

–> then as country substitutes for bio fuel, the demand for biofuel inputs such as corn and sugar grew

–> to grow these required more petroleum based products

–> reinforcing cycle

Question 21

short run fluctuations in the terms of trade

commodity boom: importers

Answer 21

commodity importers of food suffered when food prices rose in 2007

political unrest from high food prices led to food riots
(burkina faso, egypt, morocco)

some buyers hoarded goods= further increase in price

Question 22

short run fluctuations in the terms of trade

commodity boom: exporters

Answer 22

countries getting higher prices for their exports

increase terms of trade could be an advantage

rare rise in their income

they can afford to import more and better capital goods

pay down international debt faster

make brief advances towards a better living standard

boom fades quickly and countries may miss the opportunity

Question 23

short run fluctuations in the terms of trade

commodity boom: government

Answer 23

whether a country imports or exports commodities during a boom

gov tend to struggle to make effective policies to handle the disruptions

commodity exporters face the decision of how to manage their sudden increase in income + worry about the appreciation of their currency

commodity importers panic at the sudden increase in necessary consumption of production costs, and worry about paying for a spike in the trade deficit

Question 24

long term deterioration of trade and LEDCs

relatively developed countries

Answer 24

relatively developed countries have more elastic X thus a deterioration

= lower export prices will eventually result in enough overall increased total X rev

to compensate for the initial decreased terms of trade purchasing power

+ these goods are more income elastic so global income increases will ensure growing demand

Question 25

long term deterioration of trade and LEDCs

middle income countries

Answer 25

likely to either benefit from an improved terms to trade, or at least suffer less under a deterioration

diversified: price of their X does not change uniformly in one direction= < fluctuation in terms of trade

Question 26

long term deterioration of trade and LEDCs

developing countries

Answer 26

LDCs often gain most of their X rev from commodities

market for commodities has relatively low income elasticity: as global income grows the demand of these goods grows rather slowly

undiversified countries terms of trade deteriorate LR

= LDC experience ever decreasing share of world output and resources

the consumption of needed M (capital goods, healthcare items…) is more difficult and requires more and more export sales (at a lower price)

economic dev is stifled

Question 27

INFLATIONARY GAP

Answer 27

the economy is (in equilibrium)at a level of output that is greater than the full employment level of output or above potential output
OR
an increase in aggregate demand (when the economy is at full employment) results in an increase in the average price level with no increase in real GDP.

Question 28

FINANCIAL ACCOUNT

Answer 28

flows of foreign direct investment

flows of portfolio investment

changes in reserve assets.ORAn explanation that it is the net change in foreign ownership of domestic financial assets

Question 29

INVESTMENT

Answer 29

any addition to the capital stock of the economy
OR
expenditure/spendingby firms on capital

Question 30

FUNCTION OF IMF

Answer 30

ensure the stability of the international monetary system

promote international monetary cooperation

lend money to help members in balance of payments difficulties