TERMS OF TRADE Flashcards
terms of trade
ratio of a country’s average price of exports to the country’s average price of imports
terms of trade equation
index of av. X price / index of av. M price x 100
short run changes in terms of trade
- demand changes
- supply changes
- relative inflation rates
- changes in the exchange rates
long run changes in the terms of trade
- when global demand is altered by income changes
- productivity changes
- monopoly power
- trade protectionism
SR changes-demand changes
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
SR changes-supply changes
if many countries join a market and create a surplus, then a country’s export prices are likely to drop
1980s market for coffee
SR changes-relative inflation rates
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
SR changes-changes in the exchange rates
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
LR changes-when global demand is altered by income changes
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
LR changes- productivity changes
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
LR changes-monopoly power
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
LR changes-trade protectionism
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
terms of trade and the trade balance
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
causes for improvements in the terms of trade x4
increase in demand for exports
decrease in supply of exports
domestic inflation raises export prices
changes in the exchange rate
causes for improvements in the terms of trade
increase in demand for exports
due to: change in taste and preferences, increased price of a competitors good, rising incomes abroad…
total rev increases+ improve in trade balance
causes for improvements in the terms of trade
decrease in supply of exports
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
causes for improvements in the terms of trade
domestic inflation raises export prices
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
causes for improvements in the terms of trade
changes in the exchange rate
depreciation–> decrease ToT–> elastic–> improves T.B
–> inelastic–> worsens T.B
appreciation–> increase ToT–> elastic–> worsens T.B
–> inelastic–> improve T.B
short run fluctuations in the terms of trade
commodity booms
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
short run fluctuations in the terms of trade
commodity speculation + interrelated nature of food and fuel
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
short run fluctuations in the terms of trade
commodity boom: importers
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
short run fluctuations in the terms of trade
commodity boom: exporters
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
short run fluctuations in the terms of trade
commodity boom: government
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
long term deterioration of trade and LEDCs
relatively developed countries
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
long term deterioration of trade and LEDCs
middle income countries
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
long term deterioration of trade and LEDCs
developing countries
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
INFLATIONARY GAP
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.
FINANCIAL ACCOUNT
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
INVESTMENT
any addition to the capital stock of the economy
OR
expenditure/spendingby firms on capital
FUNCTION OF IMF
ensure the stability of the international monetary system
promote international monetary cooperation
lend money to help members in balance of payments difficulties
