Question

Write a short note on the terms of trade.

Short answer

Answer: Terms of trade is the rate at which goods or services are exchanged between countries in international trade, and it is essentially the ratio of a country's export prices to import prices. Favorable terms of trade indicate that a country can buy more imports with the same amount of exports, while unfavorable terms of trade mean that a country must export more to purchase the same amount of imports. Factors that can influence a country's terms of trade include currency exchange rates, supply and demand, changes in production costs, and trade barriers.

Step-by-step solution

Define Terms of Trade

Terms of trade refers to the rate at which goods or services are exchanged between countries through international trade. More specifically, it is the ratio of export prices to import prices for a country. A favorable terms of trade means that a country can buy more imports with the same amount of exports, while an unfavorable terms of trade indicates that a country has to export more to purchase the same amount of imports.

Provide an Example

Suppose Country A exports 1 unit of electronics to Country B and imports 2 units of textiles from Country B. The terms of trade for Country A can be calculated as the value of electronics exports (in terms of textiles) divided by the value of textiles imports. If 1 unit of electronics costs 100 dollars and 1 unit of textile costs 50 dollars, the terms of trade for Country A would be 100/50, which equals 2. This means that Country A can exchange 1 unit of its electronics for 2 units of textiles from Country B.

Discuss Factors Affecting Terms of Trade

Factors that influence a country's terms of trade include currency exchange rates, supply and demand, changes in production costs, and trade barriers. Stronger exchange rates can improve a country's buying power, leading to favorable terms of trade. Likewise, a higher demand for a country's exports will increase export prices and improve terms of trade. However, changes in production costs, such as higher wages or input prices, can reduce the competitiveness of a country's exports and lead to unfavorable terms of trade. Finally, trade barriers like tariffs and quotas can also affect terms of trade by increasing the cost of exports or limiting the access to foreign markets.