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Terms of Trade (1).pptx

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Terms of Trade (1).pptx

  1. 1. Terms of Trade
  2. 2. Terms of Trade - Meaning How the gain from international trade would be shared by the participating countries depends upon the terms of trade. The terms of trade refer to the rate at which one country exchanges its goods for the goods of other countries.  Thus, terms of trade determine the international values of commodities.  Obviously, the terms of trade depend upon the prices of exports a country and the prices of its imports. When the prices of exports of a country are higher as compared to those of its imports, it would be able to obtain greater quantity of imports for a given amount of its exports. In this case terms of trade are said to be favorable for the country as its share of gain from trade would be relatively larger
  3. 3. Concepts of Terms of Trade Net Barter Terms of Trade  The most widely used concept of the terms of trade is what has been caned the net barker terms of trade which refers to the relation between prices of exports and prices of imports. In symbolic terms: Tn = Px/Pm Where Tn stands for net barter terms of trade. Px stands for price of exports (x), Pm stands for price of imports (m).
  4. 4. Gross Barter Terms of Trade This concept of the gross terms of trade was introduced by F.W. Taussig and in his view this is an improvement over the concept of net barter terms of trade as it directly takes into account the volume of trade. Accordingly, the gross barter terms of trade refer to the relation of the volume of imports to the volume of exports. Thus, Tg = Om/Qx Where Tg = gross barter terms of trade, Qm = quantity of imports Qx = quantity of exports
  5. 5. Income Terms of Trade In order to improve upon the net barter terms of trade G.S. Dorrance developed the concept of income terms of trade which is obtained by weighting net barter terms of trade by the volume of exports. Income terms of trade therefore refer to the index of the value of exports divided by the price of imports. Symbolically, income terms of trade can be written as Ty = Px.Qx/Pm Where Ty = Income terms of trade Px = Price of exports Qx = Volume of exports Pm= Price of imports
  6. 6. Factors Affecting the Terms of Trade
  7. 7. 1. Reciprocal Demand The reciprocal demand signifies the intensity of demand for the product of one country by the other. If the demand for cloth, exportable commodity of country A, is more intense (or inelastic) in country B, the latter will offer more units of steel, its exportable product, to import a given quantity of cloth. On the contrary, if the demand for cloth in country B is less intense (elastic), then B will offer smaller quantity of steel to import the given quantity of cloth.
  8. 8. 2. Tariff When a country imposes tariffs on imports from the foreign country, it implies a lesser willingness to absorb the foreign products.  It means the reciprocal demand in the tariff imposing country for the foreign product has got reduced. The tariffs or import duties are, therefore, likely to improve the terms of trade for the tariff- imposing country.  The tariff will improve the terms of trade for the tariff-imposing country, if the elasticity of offer curve of the other country is more than unity but less than infinity. If the foreign country B imposes retaliatory tariff of the equivalent or relatively larger magnitude, the effect of imposition of tariff by the first country A may get off-set or more than off-set.
  9. 9. 3. Changes in Tastes The terms of trade of a country may also be affected by the changes in tastes. If tastes or preferences of the people in country A shift from the product Y of country B to its own product X, the terms of trade will become favorable to country A. In an opposite situation, the terms of trade will turn against this country.
  10. 10. 4. Changes in Factor Endowments If there is an increase in the supply of labor in country A, specializing in the production of labor-intensive commodity cloth, while factor endowments in country B remain unchanged, the fall in labor cost will lower the price of cloth. Consequently, more quantity of cloth will be offered by country A for the same quantity of steel resulting in the terms of trade becoming unfavorable to A. If labor becomes scarcer in this country, the terms of trade are likely to become favorable for it.
  11. 11. 5. Changes in Technology The terms of trade of a country get affected also by the changes in techniques of production.  As there is technological improvement in the home country, say A, there is rise in productivity and/or a fall in the cost of producing exportable commodity, say cloth. If the technological progress is labor-saving in this labor-intensive export sector (cloth industry) there will be worsening of the terms of trade as the offer curve of country A will shift to the right.
  12. 12. 6. Economic Growth The economic growth involves a rise in real national product or income of a country over a long period. As growth takes place, there is an expansion in the productive capacity of the country. The increased productive capacity may result from the increased supply of productive factors.  It is supposed that there are two countries A and B. The former is the labor-abundant home country and cloth is its exportable product, which is labor-intensive. Steel, the capital-intensive commodity, is its importable product from the foreign country B. The offer curves of two countries are given.
  13. 13. 7. Devaluation Devaluation is the reduction of the value of home currency in relation to the value of foreign currency. Since devaluation causes a lowering of export prices relative to import prices, the terms of trade are supposed to get worsened after devaluation of the home currency.
  14. 14. 8. Balance of Payments Position  If a country is faced with a deficit in balance of trade and payments and it has to adopt measures intended to restrict import and enlarge exports such as internal deflation, devaluation, import and exchange controls, the terms of trade are likely to get worsened.  On the opposite, a trade and payments surplus may be tackled through the exchange appreciation and reflationary policies. As a consequence, the terms of trade may get improved.
  15. 15. 9. International Capital Flows An increased flow of capital from abroad involves larger demand for the products of the creditor country and consequent rise in the prices of imported goods. The rise in prices of imports relatively to the prices of exports causes deterioration in the net barter terms of trade. When the borrowing country makes repayments of outstanding loans, there is outflow of capital. In order to get hold of required foreign currencies for making repayments, there may be sale of home-produced goods at rather low prices. The fall in export prices relative to import prices will again result in the deterioration in the net barter terms of trade.
  16. 16. 10.Nature of Goods If a country is producing and exporting only primary goods, and importing manufactured goods, the terms of trade will be unfavorable 11. Size of Population An overpopulated country will have larger demand for imports. As a result, the terms of trade will tend to be unfavorable in this case relative to the under populated or optimally populated country

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