Terms of trade refer to the rate at which a country exchanges products for those of other countries. Terms of trade can also be defined as the relationship between the prices of a country’s export and prices of its import i.e the rate at which country export exchanges for a unit of its import.
Thus index of term of trade =
\( \frac{Price \; index \; of \; export}{Price \; index \; of \; import} \; \times \; \frac{100}{1} \)
This can further be expressed as
\( \frac{px}{pm} \; \times \; \frac{100}{1}\)
Where px = Index of export prices
pm = Index of import prices
TOT = Terms of trade
Example
A country’s export price $120 while that of import is N80 what is the term of trade (TOT)
Solution
TOT = \( \frac{px}{pm} \; \times \; \frac{100}{1}\)
px = 120
pm = 80
TOT = \( \frac{120}{80} \; \times \; \frac{100}{1} \\ = \scriptsize 150 \%\)
= 150% which is favourable.
If the price at which a country’s export exchange for the import is greater, it is called favourable terms of trade. But if that of the imports is greater than exports the country experiences unfavourable terms of trade.
Factors Affecting Terms of Trade
- Elasticity of demand
- Elasticity of supply
- Types of product
- Availability of substitute
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