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Terms of trade

The terms of trade (TOT) is the relative price of exports in terms of imports[1] and is defined as the ratio of export prices to import prices.[2] It can be interpreted as the amount of import goods an economy can purchase per unit of export goods.

An improvement of a nation's terms of trade benefits that country in the sense that it can buy more imports for any given level of exports. The terms of trade may be influenced by the exchange rate because a rise in the value of a country's currency lowers the domestic prices of its imports but may not directly affect the prices of the commodities it exports.

History edit

The expression terms of trade was first coined by the US American economist Frank William Taussig in his 1927 book International Trade. However, an earlier version of the concept can be traced back to the English economist Robert Torrens and his book The Budget: On Commercial and Colonial Policy, published in 1844, as well as to John Stuart Mill's essay Of the Laws of Interchange between Nations; and the Distribution of Gains of Commerce among the Countries of the Commercial World, published in the same year, though allegedly already written in 1829/30.

Definition edit

Terms of trade (TOT) is a measure of how much imports an economy can get for a unit of exported goods. For example, if an economy is only exporting apples and only importing oranges, then the terms of trade are simply the price of apples divided by the price of oranges — in other words, how many oranges can be obtained for a unit of apples. Since economies export and import many goods, measuring the TOT requires defining price indices for exported and imported goods and comparing the two.[3]

A rise in the prices of exported goods in international markets would increase the TOT, while a rise in the prices of imported goods would decrease it. For example, countries that export oil will see an increase in their TOT when oil prices go up, while the TOT of countries that import oil would decrease.

Two country model CIE economics edit

In the simplified case of two countries and two commodities, terms of trade is defined as the ratio of the total export revenue[clarification needed] a country receives for its export commodity to the total import revenue it pays for its import commodity. In this case, the imports of one country are the exports of the other country. For example, if a country exports 50 dollars' worth of product in exchange for 100 dollars' worth of imported product, that country's terms of trade are 50/100 = 0.5. The terms of trade for the other country must be the reciprocal (100/50 = 2). When this number is falling, the country is said to have "deteriorating terms of trade". If multiplied by 100, these calculations can be expressed as a percentage (50% and 200% respectively). If a country's terms of trade fall from say 100% to 70% (from 1.0 to 0.7), it has experienced a 30% deterioration in its terms of trade. When doing longitudinal (time series) calculations, it is common to set a value for the base year [citation needed] to make interpretation of the results easier.

In basic microeconomics, the terms of trade are usually set in the interval between the opportunity costs for the production of a given good of two nations.

Terms of trade is the ratio of a country's export price index to its import price index, multiplied by 100. The terms of trade measures the rate of exchange of one good or service for another when two countries trade with each other.

Multi-commodity multi-country model edit

 
The terms of trade of Australia since 1959. Note the effect of the resources boom from 2005.

In the more realistic case of many products exchanged between many countries, terms of trade can be calculated using a Laspeyres index. In this case, a nation's terms of trade is the ratio of the Laspeyre price index of exports to the Laspeyre price index of imports. The Laspeyre export index is the current value of the base period exports divided by the base period value of the base period exports. Similarly, the Laspeyres import index is the current value of the base period imports divided by the base period value of the base period imports.

 

Where

  price of exports in the current period
  quantity of exports in the base period
  price of exports in the base period
  price of imports in the current period
  quantity of imports in the base period
  price of imports in the base period

Limitations edit

Terms of trade should not be used as synonymous with social welfare, or even Pareto economic welfare. Terms of trade calculations do not tell us about the volume of the countries' exports, only relative changes between countries. To understand how a country's social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However, this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

See also edit

References edit

  1. ^ Obstfeld, M., Rogoff, K. (1996). Foundations of International Macroeconomics. Cambridge, MA: MIT Press. Page 199.
  2. ^ Reinsdorf, M.B. (2009). Terms of Trade Effects: Theory and Measurement. Bureau of Economic Analysis. Page 1.
  3. ^ Marshall, Reinsdorf (October 2009). "Terms of Trade Effects: Theory and Measurement" (PDF). working paper. BEA.

External links edit

  •   Media related to Terms of Trade at Wikimedia Commons

terms, trade, this, article, needs, additional, citations, verification, please, help, improve, this, article, adding, citations, reliable, sources, unsourced, material, challenged, removed, find, sources, news, newspapers, books, scholar, jstor, april, 2012, . This article needs additional citations for verification Please help improve this article by adding citations to reliable sources Unsourced material may be challenged and removed Find sources Terms of trade news newspapers books scholar JSTOR April 2012 Learn how and when to remove this template message The terms of trade TOT is the relative price of exports in terms of imports 1 and is defined as the ratio of export prices to import prices 2 It can be interpreted as the amount of import goods an economy can purchase per unit of export goods An improvement of a nation s terms of trade benefits that country in the sense that it can buy more imports for any given level of exports The terms of trade may be influenced by the exchange rate because a rise in the value of a country s currency lowers the domestic prices of its imports but may not directly affect the prices of the commodities it exports Contents 1 History 2 Definition 3 Two country model CIE economics 4 Multi commodity multi country model 5 Limitations 6 See also 7 References 8 External linksHistory editThe expression terms of trade was first coined by the US American economist Frank William Taussig in his 1927 book International Trade However an earlier version of the concept can be traced back to the English economist Robert Torrens and his book The Budget On Commercial and Colonial Policy published in 1844 as well as to John Stuart Mill s essay Of the Laws of Interchange between Nations and the Distribution of Gains of Commerce among the Countries of the Commercial World published in the same year though allegedly already written in 1829 30 Definition editTerms of trade TOT is a measure of how much imports an economy can get for a unit of exported goods For example if an economy is only exporting apples and only importing oranges then the terms of trade are simply the price of apples divided by the price of oranges in other words how many oranges can be obtained for a unit of apples Since economies export and import many goods measuring the TOT requires defining price indices for exported and imported goods and comparing the two 3 A rise in the prices of exported goods in international markets would increase the TOT while a rise in the prices of imported goods would decrease it For example countries that export oil will see an increase in their TOT when oil prices go up while the TOT of countries that import oil would decrease Two country model CIE economics editIn the simplified case of two countries and two commodities terms of trade is defined as the ratio of the total export revenue clarification needed a country receives for its export commodity to the total import revenue it pays for its import commodity In this case the imports of one country are the exports of the other country For example if a country exports 50 dollars worth of product in exchange for 100 dollars worth of imported product that country s terms of trade are 50 100 0 5 The terms of trade for the other country must be the reciprocal 100 50 2 When this number is falling the country is said to have deteriorating terms of trade If multiplied by 100 these calculations can be expressed as a percentage 50 and 200 respectively If a country s terms of trade fall from say 100 to 70 from 1 0 to 0 7 it has experienced a 30 deterioration in its terms of trade When doing longitudinal time series calculations it is common to set a value for the base year citation needed to make interpretation of the results easier In basic microeconomics the terms of trade are usually set in the interval between the opportunity costs for the production of a given good of two nations Terms of trade is the ratio of a country s export price index to its import price index multiplied by 100 The terms of trade measures the rate of exchange of one good or service for another when two countries trade with each other Multi commodity multi country model edit nbsp The terms of trade of Australia since 1959 Note the effect of the resources boom from 2005 In the more realistic case of many products exchanged between many countries terms of trade can be calculated using a Laspeyres index In this case a nation s terms of trade is the ratio of the Laspeyre price index of exports to the Laspeyre price index of imports The Laspeyre export index is the current value of the base period exports divided by the base period value of the base period exports Similarly the Laspeyres import index is the current value of the base period imports divided by the base period value of the base period imports p x c q x 0 p x 0 q x 0 p m c q m 0 p m 0 q m 0 100 displaystyle p x c q x 0 over p x 0 q x 0 left p m c q m 0 over p m 0 q m 0 100 right nbsp Where p x c displaystyle p x c nbsp price of exports in the current period q x 0 displaystyle q x 0 nbsp quantity of exports in the base period p x 0 displaystyle p x 0 nbsp price of exports in the base period p m c displaystyle p m c nbsp price of imports in the current period q m 0 displaystyle q m 0 nbsp quantity of imports in the base period p m 0 displaystyle p m 0 nbsp price of imports in the base periodLimitations editTerms of trade should not be used as synonymous with social welfare or even Pareto economic welfare Terms of trade calculations do not tell us about the volume of the countries exports only relative changes between countries To understand how a country s social utility changes it is necessary to consider changes in the volume of trade changes in productivity and resource allocation and changes in capital flows The price of exports from a country can be heavily influenced by the value of its currency which can in turn be heavily influenced by the interest rate in that country If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports As a result exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a supposedly high price In the real world of over 200 nations trading hundreds of thousands of products terms of trade calculations can get very complex Thus the possibility of errors is significant See also editSinger Prebisch thesis about the tendency to deterioration of the terms of trade between primary products and manufactured goods References edit Obstfeld M Rogoff K 1996 Foundations of International Macroeconomics Cambridge MA MIT Press Page 199 Reinsdorf M B 2009 Terms of Trade Effects Theory and Measurement Bureau of Economic Analysis Page 1 Marshall Reinsdorf October 2009 Terms of Trade Effects Theory and Measurement PDF working paper BEA External links edit nbsp Media related to Terms of Trade at Wikimedia Commons Retrieved from https en wikipedia org w index php title Terms of trade amp oldid 1212441174, wikipedia, wiki, book, books, library,

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