Terms of trade

We have seen that gains from trade are possible when comparative costs differ, and that the size of the overall gain and how it is distributed between countries will depend on the prices at which trade takes place. These prices (the terms of trade) will depend on the demand and supply for products of international trade. The country with the most highly desired goods on offer will receive the most advantageous terms of trade.

We define a country’s terms of trade as the quantity of that country’s exports that have to be sold per unit of imports. The terms are expressed as an index, and they are estimated by comparing the average price of exports with the average price of imports. Thus: T = pxx100 pm,where T = terms of trade, px = an index of the average price of exports and pm = an index of the average price of imports.

An ‘improvement’ in the terms of trade means that the country is able to obtain more imports for a given quantity of exports than before. This appears to be a good thing, but a country’s export prices can be driven up either by strong foreign demand or by domestic inflation. The former reason is wholly beneficial and can be regarded as a genuine improvement in that country’s external position. However, if prices are running ahead of other countries’ export prices, the benefits to be gained from the ‘improving’ terms of trade will be short-lived.

Conversely, a ‘deterioration’ in the terms of trade means that a country is able to buy less imports per unit of exports. A deterioration can be organised deliberately by a policy of currency depreciation which lowers the price of exports and raises the price of imports. Exports are therefore encouraged and imports discouraged sufficiently.

Ø Comprehension:

1. Why does international trade merit special attention?

2. What do the terms of trade depend on?

3. What does “deterioration” in the terms of trade mean?

4. How can we characterize improvement in terms of trade?

Ø Summarizing:

Complete the following sentences to summarize the text above:

1. In some respects international trade differs from … .

2. There are more obvious barriers to trade between countries than … .

3. The country’s terms of trade is the quantity of exports … .

4. Improvement in trade means … .

5. Deterioration in terms of trade means … .

Ø Text organization:

The Nationalments below express the main ideas of the text. Number them so that they are in the same order as the ideas in the text. The first one is given for you:

Ø Viewpoint:

How can you characterize the situation with the international trade in Ukraine: