Terms of Trade

Terms of Trade

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

Terms of Trade = (index of export prices / index of import prices) x 100. It measures a country’s relative competitiveness

Factors influencing a country’s Terms of Trade

  • Tariffs
  • Exchange Rate – a decline in the exchange rate will make exports cheaper, reducing the terms of trade
  • Inflation rates in other countries – higher inflation in the UK would cause exports to rise faster than imports in the short run, improving the terms of trade. However, in the long run, the exchange rate will then fall, worsening the terms of trade
  • Competitiveness of firms – raw materials and labour productivity will affect export prices and hence the competitiveness of a firm

Effect of an improvement in a country’s Terms of Trade

  • Decline in the current account of the balance of payments – the competitiveness of the country’s goods / services will fall
  • Increased living standards – country is able to import for a cheaper price and exports become more expensive

Effect of a deterioration in a country’s Terms of Trade

  • Imports become more expensive in comparison to exports – reducing the living standards
  • Foreign currency earnings are relatively less

Quick Fire Quiz – Knowledge Check

1. Define ‘Terms of Trade’ (2 marks)

2. Identify the formula to calculate the Terms of Trade (2 marks)

3. Identify and explain four factors influencing a country’s Terms of Trade (8 marks)

4. Explain the effect of an improvement in a country’s Terms of Trade (4 marks)

5. Explain the effect of a deterioration in a country’s Terms of Trade (4 marks)

 

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