The terms of trade

Question 1

Terms of trade definition

Answer 1

• Defined as the ration between average xport prices and average import prices.

Index of terms of trade =
(Index of export prices/ Index of import prices) X 100
-An increased in export prices leads to an improved terms of trade. This coccurs if the value of the currency rises
-VICE VERSA

Question 2

e.g of terms of trade calculation; if export prices rise by 5% and import rise by 2%?

Answer 2

105/102 X 100=
- 102.94

Question 3

Benefits of improved terms of trade

Answer 3

• Beneficial effect on domestic cost-push inflation as an improvement indicates falling import prices relative to exprts (therefore components imported to make other goods cheaper
• Can be beneficial if components are imported in order to then produce exported goods

Question 4

Consequences of worsening terms of trade

Answer 4

• A worsening terms of trade indicates that a country has to export more to purchase a given quantity of imports.
• Tends to be the case for Primary Product Dependant nations, that export low value goods whikst importing higher value goods

Question 5

Strategies to improve terms of trade

Answer 5

• Enhancing export competitiveness
• Improving infrastructure
• Tarrifs and Trade Agreements
• Exchange rate management
• Ecomomic stability and inflation control
• Education and workforce development

Question 6

Strategies to improve terms of trade-Enhancing export competitiveness

Answer 6

Enhancing Export Competitiveness:

• Innovation and Quality: Investing in technology and improving the quality of goods and services can make exports more attractive on the global market1
• Diversification: Expanding the range of export products and markets can reduce dependency on a few commodities and mitigate risks associated with price fluctuations.

Question 7

Strategies to improve terms of trade-Improving infrastructure

Answer 7

Improving Infrastructure:

• Transport and Logistics-Developing efficient transportation networks and logistics can lower the cost of exporting goods, making them more competitive
• Digital Infrastructure-Enhancing digital infrastructure can boost the export of services, particularly in the growing digital economy

Question 8

Strategies to improve terms of trade-Trade policies

Answer 8

Trade Policies:

• Tariffs and Trade- Agreements- Negotiating favorable trade agreements and reducing tariffs can improve access to foreign markets and make exports more competitive.
• Optimal Tariffs- Implementing optimal tariffs can help a country exploit its market power in international trade, improving its terms of trade.

Question 9

Strategies to improve terms of trade-Exchange rate management

Answer 9

Exchange Rate Management:

• Currency Appreciation- A rise in the domestic currency’s exchange rate can make imports cheaper and boost the prices of exports, improving the terms of trade
• Stable Exchange Rates-Maintaining stable exchange rates can reduce uncertainty and make trade more predictable and attractive for foreign buyers

Question 10

Strategies to improme terms of trade-Economic stability and inflation control

Answer 10

Economic Stability and Inflation Control:

• Low Inflation- Keeping inflation rates low can help maintain the competitiveness of exports by preventing domestic prices from rising faster than those of trading partners.
• Economic Policies- Implementing sound economic policies that promote growth and stability can enhance investor confidence and improve trade terms.

Question 11

Strategies to improve terms of trade-Education and Workforce Development

Answer 11

Education and Workforce Development:

• Skilled Workforce- Investing in education and training can create a more skilled workforce, capable of producing high-quality goods and services that are competitive internationally.

Question 12

Effect of change in terms of trade on BoP-Exports price elastic

Answer 12

• Improvement in terms of trade> a larger proportionate fall in export quantities/volumes.

-Negative for current account as there are less exports

Question 13

Effect of change in terms of trade on BoP-Exports are price inelastic

Answer 13

• An improvment in the terms of trade> a less than proportionate fall in export volumes.
  -improvement in current account position

Question 14

Effect of change in terms of trade on BoP-Imports are elastic

Answer 14

• Cause a deterioration on terms of trade>proportioate fall in import volumes
• Therefore beneficial for current account

Question 15

Effect of change in terms of trade on BoP-Imports are inelastic

Answer 15

• Will cause a deterioration in terms of trade>less than proportionate fall in import volumes
  -deteriorates current account position

Question 16

Effects of changes of terms of trade on the domestic economy

Answer 16

• An improvement in terms of trade caused by increasing export prices could mean that its likely for there to be a rise in import volumes.
  -With less being produces in the export sector, this could lead to a fall in GDP and a rise in unemployment
• Also an improvment in terms of trade may mean we import more price inelastic goods which have fewer substitutes
  -therefore, good produced by our export sector have have reduced demand.

Question 17

Factors affecting terms of trade

Answer 17

• Exchange rate
• Inflation in main trading partner countries
• Demand for exports and imports
• Relative productivity compared to trading partners
• Changing incomes affect patterns of demand

Question 18

Factors affecting terms of trade-Exchange rate

Answer 18

• A fall in the exchange rate should reduce the terms of trade. This is because a decline in the exchange rate will make exports cheaper.
  -An appreciation in the exchange rate should improve the terms of trade because exports will rise in price and imports become cheaper.

Question 19

Factors affecting terms of trade-Inflation in main trading partner countries

Answer 19

• Higher UK inflation would cause (at least temporary) improvement in the terms of trade as UK export prices would be rising faster than import prices. (Though inflation is likely to cause a depreciation in the exchange rate, which will cause exports to then fall in price.)

Question 20

Factors affecting terms of trade-Demand for imports and exports

Answer 20

Leads to a change in price that will change the terms of trade.
-In the long term, there will be other factors at work which affect terms of trade

Question 21

Factors affecting terms of trade-Relative productivity compared to other trading partners

Answer 21

• Should reduce the relative price of exports as higher productivity leads to lower costs of prodution
  -therefore, a relative rise in production could worsen terms of trade

Question 22

Factors affecting terms of trade-Changing incomes affecting patterns of demand

Answer 22

• As world incomes rises, for example, there has been an increase in demand for tourism. If this leads to higher prices in the tourist industry in Turkey and all other things being equal, Turkeys terms of trade will improve

Question 23

Impact of worsening terms of trade on exchange rate

Answer 23

The combined effects of reduced export revenues, increased import costs can lead to increased volatility in the exchange rate. This volatility can create uncertainty in the market, further impacting trade and investment decisions.