12 terms

Terms of Trade

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Define 'Terms of Trade'
Concept that relates the prices that a country receives for its exports to the prices it pays for its imports.
Define the equation of 'Terms of trade'
(Average price of exports ÷ Average price of imports) × 100
Define 'Improvement in the terms of trade'
An increase in the ratio of the index of average export prices to the index of average import prices. It involves a fall in the opportunity cost of imports.
Define 'Deterioration in the terms of trade'
A decrease in the ratio of index of average export prices to the index of average import prices. It involves a increase in the opportunity cost of imports.
Referring to the AD/AS diagram, explain how 'Changes in the Global demand' affects the Terms of trade.
Global demand may change due to consumers' tastes and trend, this increases the demand for a country's export, shifting the AD curve to the right, and therefore the price of the export increases, leading to an 'improvement in the terms of trade'.
Explain how 'Changes in the Exchange rate' may affect the Terms of trade.
If the exchange rate depreciates, the price of exports also worsens, therefore the terms of trade deteriorates. If the exchange rate appreciates, the price of exports are now more expensive, therefore the terms of trade improves.
Explain how 'Changes in the rate of Inflation' may affect the Terms of trade.
If inflation occurs in the economy, the price of exports of the country will increase, leading to a improvement in the terms of trade. However this is only the case where the export's elasticity is inelastic, goods that shows small change in quantity demanded as the price changes, such as oil.
Explain how Terms of trade and the Balance of trade are related?
The balance of trade measures the value of export goods and services minus the value of import goods and services. Values of exports and imports are determined by export and import quantities times their respective prices. Since the terms of trade involve export and import prices, it follows that the changes in the terms of trade cause changes in the balance of trade.
Under what conditions can a technological advance in an export industry lead to an improvement in a country's trade balance, even though its terms of trade may deteriorate?
Technological advances decreases the cost of production therefore the price of exports decreases, leading to a deterioration in the Terms of trade. However the quantity of exports would increase due to more efficient production with technological advances, therefore the number of exports relative to the imports improves, showing an improvement in a country's trade balance.
How can improvement of terms of trade lead to greater opportunities for growth?
It can increase its imports of capital goods or other important inputs for production, and it can also enjoy improve standards of living because of the possibility of importing more consumer goods.
State two causes of changes in the Terms of trade in the short term.
Any of below:

Changes in global demand
Changes in global supply
Changes in the domestic rate of inflation relative to other countries
Changes in exchange rates
State two causes of changes in the Terms of trade in the long term.
Any of below:

Growth in incomes, affecting global demand
Changes in productivity
Technological advances
Trade protection
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