Terms of Trade

Summary

This video explains the concept of terms of trade, focusing on how it measures a nation's export prices relative to its import prices. The speaker breaks down the equation used to calculate this and highlights the importance of terms of trade, especially for developing countries. Factors like inflation, exchange rates, demand, and supply changes can impact the terms of trade in both the short and long term. The video also touches on how productivity and income patterns influence these figures, and how improvements or deteriorations in terms of trade are not always straightforward in their implications.

Takeaways

• 📊 The terms of trade is calculated by taking the weighted average of export prices divided by the weighted average of import prices, multiplied by 100.
• 🛒 The concept involves comparing baskets of exports and imports, similar to the Consumer Price Index (CPI), where the prices of these baskets are used to assess trade balance.
• 🔄 Terms of trade is presented as an index, starting from a base year where the index value is set to 100, and subsequent years are compared against this base year.
• 🌍 Terms of trade are particularly important for developing nations, which rely on export revenues to purchase imports that they do not produce domestically.
• 📈 An improvement in terms of trade occurs when the price of exports rises or the price of imports falls, allowing the nation to buy more imports with the same quantity of exports.
• 📉 A deterioration in terms of trade means that the price of exports has decreased or the price of imports has increased, requiring more exports to purchase the same level of imports.
• ⏳ Short-run factors affecting terms of trade include changes in demand and supply, weather conditions, inflation rates, and exchange rates, which cause quick fluctuations.
• 📈 Long-run factors, like income changes, productivity improvements, and technological advancements, can have sustained impacts on terms of trade over time.
• 🌱 Developing countries, especially those exporting primary commodities, may see long-term deterioration in their terms of trade due to inelastic demand for these commodities compared to manufactured goods.
• ⚖️ Higher productivity and technological advancements may lower export prices, leading to a deterioration in terms of trade, but can improve a nation's competitiveness overall.

Q & A

What is the basic formula for calculating the terms of trade?

The terms of trade is calculated by dividing the weighted average of export prices by the weighted average of import prices and multiplying the result by 100.

How are the 'baskets' of exports and imports created for the terms of trade calculation?

The baskets of exports and imports are created by selecting the most popular exports and imports for a nation, weighting them according to revenue (for exports) or expenditure (for imports), and calculating an overall price for each basket.

What does an improvement in the terms of trade mean?

An improvement in the terms of trade means that a nation’s basket of exports can now buy more imports than before. This could occur due to an increase in export prices, a decrease in import prices, or both.

What happens when there is a deterioration in the terms of trade?

A deterioration in the terms of trade means that the price of the basket of exports has decreased, or the price of the basket of imports has increased, making it harder for a nation to purchase the same amount of imports with its exports.

Why is the terms of trade concept especially important for developing countries?

Developing countries rely heavily on export revenues to purchase imported goods, especially manufactured products they cannot produce. A deterioration in the terms of trade means they must sell more exports to afford the same level of imports.

What are some short-run factors that can affect the terms of trade?

Short-run factors include changes in the demand and supply for exports and imports, changes in taste or fashion, supply conditions like weather, relative inflation rates, and fluctuations in exchange rates.

How can changes in income patterns affect the terms of trade in the long run?

In the long run, changes in income patterns, particularly in developed countries, can affect the demand for different types of goods. For instance, as incomes rise, the demand for manufactured goods increases faster than the demand for primary commodities, potentially leading to a deterioration in the terms of trade for countries that specialize in exporting primary goods.

What is the Prebisch-Singer hypothesis mentioned in the script?

The Prebisch-Singer hypothesis suggests that over time, the terms of trade for countries exporting primary commodities tend to deteriorate compared to those exporting manufactured goods, as demand for primary goods is less responsive to increases in income.

How do improvements in productivity and technology impact the terms of trade?

Improvements in productivity and technology generally lead to lower costs of production, which can lower export prices, resulting in a deterioration of the terms of trade. However, these improvements can also enhance the competitiveness of a nation's exports.

Is an improvement in the terms of trade always beneficial for a country?

No, an improvement in the terms of trade is not always beneficial. For example, if higher export prices are driven by high relative inflation, the country might lose competitiveness in global markets, even though the terms of trade have improved.