Terms of trade notes

Terms of trade

Introduction	An index that shows the value of a countrys average export prices relative to their average import prices Terms of trade= Weigted index of average export prices/ weigted index of average import prices
Causes of changes in a county's	Short run causes- Changes in the conditions of demand and supply- Changes in relative inflation rates- Change in exchang rates- Long run causes- income changes- Long run improvments in productivity within a country Log run improvements in technology within a country
Elasticity of demand	Price Elasticity of demand for imports and exports Price elasticity of demand for exports – A measure of the responsiveness of the demand for exports when there is a change in the price of exports. PED exports= percentage change in demand for exports/ percentage change in average price of exports Outcome- good: if exports prices were galling exports demanded would rise by more than the price falles leading to increase in export revenues Price elasticity of demand for imports- Price elasticity of demand for imports – A measure of the responsiveness of the demand for imports when there is a change in the price of imports. PED imports= percentage change in demand for imports/ percentage change in average price of imports
How beneficial is an improvement in the terms of trade	Prices in other countries rises > domestic exports become more competitive Incomes in other countries rises > demand for goods rises Taste and preferences change towards domestic exports > higher demand for exports Higher export prices caused by domestic inflation -   Relative export prices may increase because a country is experiencing inflation that is higher than in the countries it trades with If demand is inelastic > an increase in price will lead to a smaller decrease in demand = total export revenue will rise If demand is elastic > an increase in prices will lead to a greater decrease in demand = total export revenue will fall
The significance of deteriotating TOT for Devoloping countries	Countries dependent on one or two major exports - downward trend in comodoty prices for many years because- •       A substantial increase in the supply for commodities (mainly caused by improvements in technology) •       The discovery of synthetic replacements for natural commodities (such as plastics replacing metals…) •       As developed countries become richer, incomes have risen > demand for commodities has not risen as much as demand for manufactures goods (manufactured goods tend to have an income elastic demand unlike commodities) •       Agricultural policies in developed countries have had a damaging effect on world agricultural markets. (over-production by domestic producers in developed countries is sent to the world market, pushing down the overall market prices > considered a form of DUMPING and ruining developing country’s agricultural industries •       Huge leaps in technology, products have become smaller Harmful consequences- •       Developing countries have to sell more and more exports to buy the same amount of imports - causing even lower prices for commodities •       High levels of indebtedness are harder to pay back  causing, once again, even lower prices for commodities Overusing of resources to increase export revenue -massive deforestation, desertification, soil erosion