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The Terms of Trade

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This revision presentation guides students through an introduction to the terms of trade. It explains what the terms of trade are and why they matter.

This revision presentation guides students through an introduction to the terms of trade. It explains what the terms of trade are and why they matter.

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  • 1. The Terms of Trade A2 Macro
  • 2. What are the terms of trade? • The terms of trade measures the relative prices of the products that we export compared to the cost (prices) of the goods and services that we import
  • 3. How do we measure the terms of trade? • By dividing an index of export prices by an index of import prices • If the terms of trade index goes up, we say that the terms of trade have improved • If the index falls, we say that the terms of trade have deteriorated
  • 4. Why does this matter? • The terms of trade affect the gains from trading with other countries • It also impacts on variables such as the balance of payments and living standards
  • 5. Australia Australia is heavily dependent on trade For most commodities, Australian traders are price takers in global markets Substantial trend improvement in the Australian terms of trade over the last ten- to-twelve years Reflects the global commodity boom and appreciating Australian dollar Improvement in terms of trade Terms of trade now starting to move lower – mining boom is coming to an end
  • 6. Brazil Another country whose terms of trade is sensitive to world commodity prices and fluctuations in their exchange rate against the US dollar
  • 7. Brazilian Export and Import Prices Charts show an index of export and import prices, January 2007 = 100 For Brazil, both export and import prices have risen But the rise in the unit price of her exports has been faster than import price inflation This has caused the Brazilian terms of trade to improve
  • 8. Japan Japan is an example of a country whose terms of trade have deteriorated over the last 10 – 15 years What factors might explain this trend for Japan? Consider the macro problems that have confronted Japan since the early 1990s Worsening of the terms of trade
  • 9. JapanWorsening of the terms of trade Trend fall in the index of Japanese export prices
  • 10. JapanWorsening of the terms of trade Trend rise in the index of Japanese import prices
  • 11. Terms of trade and the exchange rate • The terms of trade ratio is heavily influenced by changes in the exchange rate • A rise in the value of a country domestic currency decreases prices for its imports but also makes exports less competitive • Thus a higher currency improves the terms of trade but might worsen the balance of trade
  • 12. Significance of the Terms of Trade Changes in the prices of the items we have to import Standard of Living Affects relative prices of capital inputs needed to sustain growth Prices of Imported Technology Export and import prices affect the value of trade flows Balance of Payments Improved terms of trade might mean we are able to import cheaper food
  • 13. Significance of the Terms of Trade Changes in the prices of the items we have to import Standard of Living Affects relative prices of capital inputs needed to sustain growth Prices of Imported Technology Export and import prices affect the value of trade flows Balance of Payments Improved terms of trade might mean we are able to import cheaper food A weak exchange rate increases the prices of imports – worsens the terms of trade – e.g. makes imports of new technology more expensive
  • 14. Significance of the Terms of Trade Changes in the prices of the items we have to import Standard of Living Affects relative prices of capital inputs needed to sustain growth Prices of Imported Technology Export and import prices affect the value of trade flows Balance of Payments Improved terms of trade might mean we are able to import cheaper food A weak exchange rate increases the prices of imports – worsens the terms of trade – e.g. makes imports of new technology more expensive Important not to confuse the terms of trade with the balance of trade!
  • 15. More great study resources from tutor2u: Economics Blog A2 Macro Revision Notes