Terms of Trade, WTO & Protectionism

Question 1

What is meant by ‘terms of trade’ and how is it calculated?

Answer 1

The price of a countries exports relative to the price of its imports.

Index of average export prices / index of average import prices X 100

E.g If index export prices increased 10% and import 5%, the terms of trade would be (110/105)x 100 = 104.8. This means that the terms of trade has increased 4.8%.

Question 2

Key things to know about the terms of trade:

Answer 2

1. If export prices on average are rising more that import prices, then the terms of trade should be above 100 - this is known as a ‘favourable movement’ - as it means that a lower quantity of exports are needed to buy a certain quantity of imports.
2. If the index falls below 100, it is an ‘unfavourable movement’ - as it means a higher quantity of exports are needed to buy that amount of imports.

Question 3

Changes in the terms of trade?…

Answer 3

1. The exchange rate (most common cause)
2. Relative inflation rates - causes changes in cost of production

Overtime the terms of trade in developed economies remain broadly stable.

However LDCs with economies dependant on a narrow range of exports, changes in the terms of trade can have a dramatic and significant effect - LDCs largely have unfavourable terms of trade.
This typically flies in the face of comparative advantage, as nations should seek structural change rather than relying on the good they have this advantage in.

Question 4

What are the problems with LDSc depending on primary produce?

Answer 4

1. Prices of primary commodities are very unstable in the short term - uncertainty about exchange rate and farmers incomes.
2. Falling prices of primary products in the long term - declining terms of trade for LDCs dependant on commodity exports which worsens the balance of payments - this makes it difficult to pay for imports.

Question 5

Why are the prices of primary commodities unstable?

Answer 5

1. PED is relatively price inelastic. Neither foodstuffs nor minerals have many close substitutes.
2. PES in the short term is inelastic - takes time to extract minerals and once planted seeds hard to change or expand

The combined effect of inelastic supply and demand fpr commodities means that a relatively small shift in demand or supply will have a large impact on price.
(Refer back to yellow sheet for price instability graphs)

Question 6

What did the Prebisch-Singer hypothesis suggest?

Answer 6

It suggest that countries which focus on the exports of primary produce will experience a continual deterioration in their terms of trade.
(See yellow sheet for further detail)

Question 7

What is the World Trade Organisation? (WTO)

Answer 7

‘The WTO is the only international organisation dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible’

1. It has 150 member states - which 3/4 are developing countries
2. Decisions are made by consensus.
3. It helps settle trade disputes and increase trade with lower barriers
4. Helps producers export more

Question 8

Arguments in favour of protectionism?

Answer 8

1. Infant industries - new industries with the potential to achieve a comparative cost advantage in the future may need temporary protection from foreign competition
2. National security - a country may need a particular industry for defence purposes
3. Protect jobs - protectionism can create or preserve jobs
4. Environmental arguments - prevent an increased carbon footprint - less trade = less fuel etc

Question 9

Methods of protectionism?

Answer 9

1. Tariffs - a tax on imported goods - raises the price which results in a fall in demand resulting in a fall of imports
2. Quota - a physical limit on the quantity of a good which can be imported - reduces quantity of imports, resulting in a larger market share available to domestic producers

(see notes for me detailed definition and graphs)