8/18/2019 IB Terms of Trade Note

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 Terms of trade notes

Basics

• Prices of exports and imports are measured in terms of domestic currency• Measures ‘P’ of ‘X’ relative to ‘P’ of ‘M’

• Measures the amount of ‘M’s that can be bought per unit of ‘X’s

• Inc. ‘P’ of ‘X’ (hen P of M is constant!

o " more Ms can be bought ith the same #uantity of Xs

TOT improvement / deterioration

• Improvement$o %n inc. in the value of the ratio of average export prices to average

import prices.o (hen price of exports inc. & price of imports dec.  the value of terms

of trade inc.!o 'all in the opp. cost of imports

• eterioration$

o % dec. in the value of the ratio of average export prices to average

import priceso (hen price of imports inc. & price of exports dec.  the value of terms

of trade dec.!o )ise in the opp. cost of imports

Factors that caused changes in TOT

Short term

In*ation   • +igher rate of domestic in*ation " country’s export prices

increase relative to its import prices%t the same time, this corresponds to a deterioration in the terms oftrade of countries that import goods from the high in*ation country.

-hanges in relative in*ation rates if a country experiences in*ation,then the price of its exports ill rise so their ill be an improvement  in

its terms of trade.

/xchangerate

-hanges in exchange rates if a country experiences appreciation,then the price of its exports ill rise so their ill be an improvement  inits terms of trade.

%ppreciation price increases

• put bac0 into e#uation 1 improvement  in terms of trade

2lobaldemand

-hanges in demand conditions for exports and imports if orlddemand for a country3s exports increases then its terms of trade illimprove.

2lobal -hanges in global supply of ma4or resources, such as oil if an oil

8/18/2019 IB Terms of Trade Note

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8/18/2019 IB Terms of Trade Note

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 Terms of trade notes

(usually in developing countries! therefore face deterioration intheir terms of trade as the price of their export goods falls.