Terms of trade (TOT)
The terms of trade measures the purchasing power of a country's exports, e.g. how many units of exports are needed to buy a unit of imports. As each country is exporting and importing many different products, the Terms of Trade are calculated using the export price index (shows combined price changes of all exported products) and import price index (shows the combined changes in prices of all imported goods).
An improvement in the terms of trade must mean that one of the following changes has taken place:
- Export prices have risen, import prices have stayed the same
- Export prices have risen, import prices have fallen
- Export prices have risen faster than import prices
- Export prices have fallen by less than import prices
- Export prices have stayed the same but import prices have fallen
A increase in the terms of trade ratio is generally described as an improvement, or favourable movement, in the terms of trade. This is because the same volume of exports will now buy more imports.
A decrease in the terms of trade ratio is generally described as a deterioration, or a worsening or unfavourable movement, in the terms of trade. This is because the country can afford fewer imports with the same volume of exports.
Task - Terms of trade
Go to the national statistics for the country where you live and find the terms of trade figures for recent years. To find the National Statistics sites for different countries, you could use the OFFSTATS site. Select the 'Browse' link and then the country you require. This will give links usually to the National Statistics provider for each country. Consider the changes that have taken place and assess how these may have affected the economy. Once you have done this move onto the next section to see what the changes might mean.
Now, what about a deterioration in the terms of trade? What changes have happened to export and import prices to cause this? Have a think about this and then follow the DECREASE in terms of trade link to compare your thoughts with ours.