Terms of Trade

Aims

• Define Terms of trade (TOT)

• Consequences of changes in TOT- (BoP & Domestic econ)

• Significance for developing countries

HL ONLY

• Measurement of TOTCauses of changes in TOTPED for X and M

Define Terms of Trade

• The amount of export goods needed to buy a set amount of imports.

or

• The ratio of export prices to import prices

• X/M

• (It is trade weighted)

It depends upon…

• volume of goods traded,

• prices

• Exchange rates

Caveat

• Improvements in TOT can be bad!

• Be warned!

Consequences of an improvement in TOT

• Price of exports rise COULD mean an improvement in the BofP. (Depends on PED)

• Price of imports falls, COULD mean an improvement in the BofP. (Depends on PED)

• Living standards rise as imports become relatively cheaper.

THINK!

• Obviously the whole good/bad thing depends upon WHY the TOT have changed.

Consequences of a deterioration in TOT

• Price of exports falls COULD mean an improvement in the BofP. (Depends on PED)

• Price of imports rises, COULD mean an improvement in the BofP. (Depends on PED)

• Higher priced imports may reduce living standards

• Foreign debt repayment is relatively more expensive.

Developing countries

• TOT is particularly serious for developing countries….

Why? I hear you ask

1. They are often dependent upon a narrow range of goods for income

2. These are usually Primary resources.

3. Any change in the price or demand for that will have huge impact on their BofP.

Why is the effect negative?

in supply of primary products in synthetic substitutes

• Protectionist agriculture policies in supply, which is dumped on world mkts, lowering prices

• Miniaturisation of production in D

But it gets worse…

• TOT deteriorate so need to sell more to buy imports.

to an in supply which leads to a in price.

• High indebtedness means even more money is spent on debt repayment.

• Has also led to environmental degradation.

Causes of changes in TOT: HL only

SHORT RUN

• Exchange rate

• D for X

• Protectionist policies

• Inflation

Causes of changes in TOT: HL only

• Successful supply side policies or in productivity would lower domestic prices

world supply can lead to gluts which drive down P

Y will change demand patterns