The+Terms+of+Trade


 * The Terms of Trade **
 * [|Learning Outcomes template] **

This is the rate that trade will take place at. Specifically it looks at the relative prices of a country’s imports and exports.

It is measured by: __ Index of Export Prices __ x 100 Index of Import Prices

Thus if the price of imports increases by 20%, say due to devaluation, this will thus affect the terms of trade: __ 100 __ x 100 = 83.3 120

A fall in the terms of trade is referred to as a deterioration.(even though this may have a positive effect on our relative competitiveness).

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 * How do The Terms of Trade affect a country? **

How beneficial is an improvement in the TOT?

Remember an improvement means that export prices increase at a faster rate than import prices?

Why might this be ie **what causes a country’s Terms of trade to change?**

**Changes in Demand and Supply:** Less important than short term factors influencing price are long term changes in Supply and Demand. For examples if demand for your exports is income inelastic then you may have seen prices fall in relative terms in the last 50 years as incomes worldwide have increased. (see below for a more detailed explanation of this)

Generally should make B of P worse for many countries, particularly if demand is price elastic.
 * Inflation **

However if T of T improves because of say more demand for our goods then we should sell more exports at a higher price, which can only be good for our B of P

If exchange rate appreciates this will improve our T of T. again if PEDs are elastic will worsen our B of P
 * Exchange Rate **


 * The significance of a deteriorating T of T for LEDCs **

Many LEDCs are dependent on a few commodities such as coffee and other agricultural products that they export. The problem here is that for many years there have been a downward trend in commodity prices (however for many commodities this has recently changed… but that’s another story)


 * The reduction in prices is due to a number of factors: **

**Increased S**
 * ** Due to technological improvements ** (esp in agriculture) in production and extraction
 * ** Subsidies ** have increased Supply from EU and NAFTA farmers and resulted in low prices worldwide.

**Reduced D**.
 * ** due to introduction of substitute goods ** such as synthetic rubber, man made fabrics and plastics
 * ** D for commodities tends to be Income inelastic ** so D has not increased much with rising incomes
 * ** Lack of access to agricultural markets ** due to protectionism in EU and NAFTA.
 * ** Lack of access to agricultural markets ** due to protectionism in EU and NAFTA.
 * ** Lack of access to agricultural markets ** due to protectionism in EU and NAFTA.

So LEDCs find their export prices falling and as PED for these goods is inelastic, then revenue falls. This results in worsening B of P deficits, and possibly a debt crisis in LEDCs. This may lead to them having to supply more of their resources and clearly this is unsustainable and may have negative external effects on say the environment

A short term improvement in LEDCs’ TOT has occurred in the last 10 years, mainly due to the growth in China and India and their need for metals and other commodities. Whether this continues is debatable (but it looks like it is continuing).

Note that oil is a commodity and recent price increases will have helped oil producers! Why is oil different?