This revision presentation guides students through an introduction to the terms of trade. It explains what the terms of trade are and why they matter.

1. The Terms of Trade
A2 Macro

2. What are the terms of trade?
• The terms of trade
measures the
relative prices of the
products that we
export compared to
the cost (prices) of
the goods and
services that we
import

3. How do we measure the terms of
trade?
• By dividing an index of
export prices by an
index of import prices
• If the terms of trade
index goes up, we say
that the terms of trade
have improved
• If the index falls, we
say that the terms of
trade have
deteriorated

4. Why does this matter?
• The terms of trade
affect the gains from
trading with other
countries
• It also impacts on
variables such as the
balance of payments
and living standards

5. Australia
Australia is heavily dependent on trade
For most commodities, Australian traders
are price takers in global markets
Substantial trend improvement in the
Australian terms of trade over the last ten-
to-twelve years
Reflects the global commodity boom and
appreciating Australian dollar
Improvement in
terms of trade
Terms of trade
now starting to
move lower –
mining boom is
coming to an end

6. Brazil
Another country whose terms of trade is
sensitive to world commodity prices and
fluctuations in their exchange rate
against the US dollar

7. Brazilian Export and Import Prices
Charts show an
index of export
and import prices,
January 2007 =
100
For Brazil, both
export and import
prices have risen
But the rise in the
unit price of her
exports has been
faster than import
price inflation
This has caused
the Brazilian terms
of trade to
improve

8. Japan
Japan is an example of a country whose
terms of trade have deteriorated over the
last 10 – 15 years
What factors might explain this trend for
Japan?
Consider the macro problems that have
confronted Japan since the early 1990s
Worsening of the
terms of trade

9. JapanWorsening of the
terms of trade
Trend fall in the
index of Japanese
export prices

10. JapanWorsening of the
terms of trade
Trend rise in the
index of Japanese
import prices

11. Terms of trade and the exchange rate
• The terms of trade ratio is heavily influenced
by changes in the exchange rate
• A rise in the value of a country domestic
currency decreases prices for its imports but
also makes exports less competitive
• Thus a higher currency improves the terms of
trade but might worsen the balance of trade

12. Significance of the Terms of Trade
Changes in the prices of the
items we have to import
Standard of Living
Affects relative prices of capital
inputs needed to sustain growth
Prices of Imported Technology
Export and import prices affect
the value of trade flows
Balance of Payments
Improved terms of trade
might mean we are able to
import cheaper food

13. Significance of the Terms of Trade
Changes in the prices of the
items we have to import
Standard of Living
Affects relative prices of capital
inputs needed to sustain growth
Prices of Imported Technology
Export and import prices affect
the value of trade flows
Balance of Payments
Improved terms of trade
might mean we are able to
import cheaper food
A weak exchange rate
increases the prices of
imports – worsens the terms
of trade – e.g. makes imports
of new technology more
expensive

14. Significance of the Terms of Trade
Changes in the prices of the
items we have to import
Standard of Living
Affects relative prices of capital
inputs needed to sustain growth
Prices of Imported Technology
Export and import prices affect
the value of trade flows
Balance of Payments
Improved terms of trade
might mean we are able to
import cheaper food
A weak exchange rate
increases the prices of
imports – worsens the terms
of trade – e.g. makes imports
of new technology more
expensive
Important not to confuse the
terms of trade with the
balance of trade!

15. More great study resources from
tutor2u:
Economics Blog
A2 Macro Revision Notes