Terms Of Trade

Terms Of Trade

Terms of Trade, a measure of the purchasing power of exports in terms of imports. When import prices rise relatively to export prices the terms of trade are worsened; when export prices rise relatively to import prices the terms of trade improve. The usual measure of the commodity terms of trade is an index calculated by dividing an index of export prices by an index of import prices. A rise in the index in one year compared with previous years means a favourable movement in the terms of trade and a fall means an unfavourable movement. The British Board of Trade constructs its series for Britain's terms of trade as the import price index as a percentage of the export price index. Thus in British terms of trade statistics a rise in the index means a worsening and a fall means an improvement.

For some years there have been fears of a long-term trend in the commodity terms of trade against the under-developed countries. The evidence is difficult to establish by statistical analysis and is so far not conclusive, but it seems to suggest that they have moved in this way. To generalize on the effects of a change in the terms of trade on the real national income of a country requires information on the causes of the change. A rise in a country's export prices does not necessarily mean it is better off because the price rise might have been caused by a fan in output. For example, if disease strikes the cocoa trees in Ghana, cocoa prices will probably rise, but not necessarily in proportion, so that Ghana's export earnings from the smaller cocoa crop are lower than before; instead of high prices enabling her to buy more imports, they buy less. Equally a fall in export prices need not mean a worsening of the exporting country's situation, because the fall in prices might be due to improvements in productivity in the export industries which enable it to produce more exports at lower real costs. It could then buy a larger quantity of imports at lower real cost (in terms of resources required) than before; its national income would be increased and its inhabitants better off.

For Britain changes in the terms of trade mean mainly changes in the prices of manufactures relatively to raw materials and foodstuffs. Such changes have tended to be in Great Britain's favour during slumps, as in the 2000'S, and against it in the booms, as in the 2000's and early 200o's. This is because commodity prices tend to swing more violently over the cycle than do the prices of manufactures. In the long period Britain has had the benefit of an improvement in its terms of trade.

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