Q. Define Terms of Trade.
Terms of Trade: The Terms of Trade measures the
relative price of exports compared to the price of imports.
Terms of Trade = 100 * Average export prices /
Average Import prices.
Basically, the
terms of trade refers to how many exports will need to be sold in order to be
able to purchase imports.
i) If the price of
exports increases, there will be an improvement in the terms of trade.
ii) If the price
of exports falls, there will be a decline in the terms of trade.
Importance of the terms of Trade: To some extent we can use the terms of
trade to measure the strength and well-being of an economy. A prolonged fall in
the terms of trade will reduce living standards. The US, will find that it can
increasingly purchase less imports from abroad. But, at the same time it is
also quite limited. For example, a devaluation doesn’t necessarily harm a
country. A devaluation does make exports more competitive and can increase
economic growth.
There is much more to the strength of an economy than the terms of trade. For example:
There is much more to the strength of an economy than the terms of trade. For example:
- Volumes of trade
- Productivity
- Capital flows
- Economic growth
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