Terms of Trade (1 Viewer)

[eX-Bhai]

Can someone please explain this concept? Like I understand that the "proper definition" refers to the export price index relative to the import price index. But how does this exactly work? You can have an exporting good, say a loaf of bread to one million dollars, but that doesn't necessarily mean that there will be any buyers. But yeh, shouldnt the terms of trade (TOT) take into account the VOLUME of goods and not the price itself?

 

[P_Dilemma]

you're exactly right. TOT is a price, yet it is mostly used in the context of quantity bought/sold

lets try an example of country A

Import Index
100
Export Index
100

the "100" indicates the relative prices. As the ratio of the export/import index is 1, no matter what happens country A must sell the same amount of exports in order to break even with the amount of imports it buys. These numbers have NO relation to quantity bought/sold tho

Let's look at country B:

Import Index
100
Export Index
110

Here, the export/import ratio if greater (1.1), which means that B can sell less to break even with what it's buying from overseas.

[note: TOT is calculated by

ExportIndex/ImportIndex x 100

so in the case of B the index would actually be 110]

-P_D

 

[eX-Bhai]

so the volume of exported and imported goods is held constant?

 

[Always]

Isn't it just the quantity of exports you can buy proportional to the quantity of imports. So if there is an improvement in the TOT you can buy more exports relative to imports and if it deteriorates it's the opposite.

I thought it had something to do with exchange rates? ie. an appreciation would improve the TOT (or is it the other way around?)

 

[sunjet]

Obviously in the short-run, firms are going to match production to demand not prices, so there will undoubtedly be buyers. The terms of trade just gives an indication of the purchasing power of a country's exports in terms of the imports it buys. I assume it's just basically a good indicator of net exports and aggregate expenditure.

 

[gnrlies]

The ToT is an index.

It doesn't measure volume, its not designed to.

Just like a price index is aimed at comparing the change in price between one period and another:- the ToT is designed to measure the relative change in export prices relative to imports.

Nothing else....

Theres no need to complicate it beyond that

 

[eX-Bhai]

The ToT is an index.

It doesn't measure volume, its not designed to.

Just like a price index is aimed at comparing the change in price between one period and another:- the ToT is designed to measure the relative change in export prices relative to imports.

Nothing else....

Theres no need to complicate it beyond that

"comparing the change in price between one period and another" - so are you implying that it is comparing the price of exports relative to imports FOR A GIVEN QUANTITY?

 

[gnrlies]

"comparing the change in price between one period and another" - so are you implying that it is comparing the price of exports relative to imports FOR A GIVEN QUANTITY?

Its got nothing to do with quantity

Look at the equation

Export Price Index / Import Price Index

Is there any reference to quantity there?

 

[Always]

This is confusing me.

How does the TOT change? Does it have to do with exchange rate fluctuations or more the changes in demand and supply?

 

[gnrlies]

Everyone is confusing this issue beyond belief!!!

Dont take the Terms of Trade as anything more than this..

Export Price Index / Import Price Index....

It is nothing else. Its got nothing to do with supply, demand, volume, revenue, quantities sold, or anything else. If its not in the above equation, then its got nothing to do with ToT!!!!

So an improvement in the terms of trade only occurs where either export prices increase relative to import prices, or if import prices fall relative to export prices.

The export price index and the import price index are calculated in the same way as the CPI. They take a basket of our common imports, and find an average price. Vice versa for the export price index.

The thing you need to all realise is that the Terms of Trade is what is known as an economic indicator. Its not something that is designed to tell the whole story. We wouldn't look at the ToT as a sole indicator of our export performance, or anything like that. All we would use it for, is an indication of our export prices.

It could very well be that we are exporting far less and importing far more even though the ToT demonstrates an improvement. Economic indicators dont paint the whole picture, they are one piece of the puzzle.

For example in Australia at the moment, we are using the ToT to explain why the commodoties boom is so powerfull. The ToT demonstrates that the prices of commodities are increasing, and some of our imports are falling in price. And in our case, our export volumes have increased. So it demonstrates where we stand. But this picture is painted by other economic indicators, not just the ToT

 

[tenfour]

well said grnlies!!!

 

[gemrism]

Its the price of exports in relation to the price of imports