Terms of trade

  • Created by: Jeon32666
  • Created on: 14-03-19 08:11

Terms of trade

It is a numerical measure of the relationship between export prices and import prices

Terms of trade index=Index of export prices*100/Index of import prices

The prices are weighted by the relative importance of each product traded

A favourable movement in terms of trade will mean that fewer exports have to be sold to buy any given quantity of imports

An unfavourable movement or deterioration will mean that more exports have to be exchanged to gain the same quantity of imports

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Causes of changes in terms of trade

  • Changes in the world demand for a country's exports or imports
  • Changes in the world's supply for a country's exports or imports
  • Change in the exchange rate
  • Changes in the relative rates of inflation
  • Protectionism
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Adv of fall in terms of trade

  • More employment opportunities in export reliant industries
  • Improvement in economy's trade balance..... However, this will depend on the price elasticity of demand of exports and imports
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Disadv. of fall in terms of trade

  • Since a fall in terms of trade will increase the volume of exports and reduce imports, Demand pull inflation might occur if supply side is less responsive to the price level
  • The rising demand for resources may cause their prices to increase and could translate into cost-push inflation
  • A fall in terms of trade will result to higher deficit in the short run but it will improve in the long run
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