Terms of Trade I A Level and IB Economics

Summary

The video clarifies the distinction between terms of trade and balance of trade, emphasizing that terms of trade relate to prices, while balance of trade concerns the value difference between exports and imports. It explains the formula for calculating the terms of trade and the factors that can lead to improvements or deteriorations, such as changes in global demand, exchange rates, and production costs. Using examples like the UK, Australia, and Zambia, the video demonstrates how various countries experience stable or volatile terms of trade depending on their key exports and global market conditions.

Takeaways

• 📊 The terms of trade (ToT) measures the relative price of a country's exports compared to imports, while the balance of trade reflects the value difference between exports and imports.
• 💰 ToT represents the prices at which trade takes place, focusing on price indices rather than the value gap like the balance of trade.
• 📈 The ToT index formula is the index of export prices divided by the index of import prices, multiplied by 100.
• ⚖️ An improvement in ToT means export prices rise relative to import prices, while a deterioration indicates export prices fall relative to imports.
• 🚀 Factors that can improve ToT include a shift to higher-value exports, increased global demand for a country's exports, or a stronger exchange rate that reduces import costs.
• 📉 A worsening ToT can result from increased competition for exports, technological advancements reducing export prices, a recession decreasing demand, or a depreciation in the exchange rate.
• 🛑 A decline in ToT means a country must export more to maintain the same level of imports, potentially lowering real living standards and increasing inflation.
• 🛠️ However, a depreciation in exchange rates, despite worsening ToT, could make exports more competitive, leading to more jobs and investments.
• 🌍 The UK has stable ToT, while Australia and Zambia are examples of countries with volatile ToT due to external factors like commodity prices and exchange rates.
• 📉 Zambia's ToT is highly volatile due to the fluctuating global price of copper, its major export, affecting both its currency and economic stability.

Q & A

What is the key difference between the terms of trade and the balance of trade?

The terms of trade represent the prices at which trade takes place, focusing on the relative price of exports compared to imports. In contrast, the balance of trade refers to the difference in value between a country's exports and imports.

How is the terms of trade index calculated?

The terms of trade index is calculated using the formula: (Index of Export Prices / Index of Import Prices) × 100.

What does an improvement in the terms of trade signify?

An improvement in the terms of trade means that the price of a country's exports has increased relative to the price of its imports, which can lead to better economic outcomes for the country.

What are some factors that could lead to an improvement in a country's terms of trade?

Factors include switching to higher value-added industries, a rise in global demand for the country's exports, an appreciation of the exchange rate, or a reduction in the price of imports due to trade deals or falling global prices for certain technologies.

What does a deterioration in the terms of trade imply?

A deterioration in the terms of trade indicates that the price of a country's exports has fallen relative to the price of imports. This means the country must export more to afford the same quantity of imports, potentially leading to lower living standards.

What could cause a deterioration in the terms of trade?

Causes include increased global production of the country's exports, falling demand for its exports due to a global recession, a depreciation of the exchange rate, or increased import prices due to trade tariffs or a rise in essential raw materials.

How does a fall in the terms of trade affect a country's economy?

A fall in the terms of trade can lead to higher import prices, reducing real living standards and increasing inflation. However, it can also make exports more competitive, potentially boosting employment and investment.

What is the relationship between the terms of trade and the exchange rate?

An appreciation of the exchange rate can improve the terms of trade by reducing the price of imports. Conversely, a depreciation of the exchange rate can worsen the terms of trade by making imports more expensive.

Why is Zambia's terms of trade highly volatile?

Zambia's terms of trade is volatile because it is heavily reliant on copper exports, and the global price of copper is subject to significant fluctuations. This causes corresponding volatility in Zambia’s trade balance and currency.

How did Australia’s terms of trade change between 2000 and 2010, and why?

Australia's terms of trade improved significantly between 2000 and 2010 due to high global prices for key exports like coal and iron ore, as well as a strong Australian dollar, which lowered the cost of imports.