A country's terms of trade (ToT) is the weighted average of its average export prices over it's average import price times 100. A value of 100 means the prices for both are the same, but if in the next year the country sees a ToT of 103, that means the country's exports now buy 3% more than what they did the year before and we've seen an improvement in the terms of trade. Conversely, if the number is 97, then the country's exports can now only buy 97% of what they could wth their exports. This is a deterioration of a country's terms of trade.
Why do ToT's change?
In the SR...
- forces of supply and demand for exports
- relative inflation increases or decreases
- exchange rate fluctuations
In the LR...
- consumer incomes
- improvement in worker/FoP productivity
PED for exports: %∆ demand for exports / %∆ average price of exports
- if elastic, good for when export prices are falling (bigger change in demand, more export revenue)
PED for imports: %∆ demand for imports / %∆ average price of imports
- if inelastic, bad for when export prices are falling (smaller change in demand, less revenue)
Interesting article : Coping with Terms-of-Trade Shocks in Developing Countries (please read and evaluate)
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