Terms of Trade
AdvancedThe terms of trade are the ratio of a country's export prices to its import prices, usually expressed as an index, showing how many imports it can buy with a given quantity of exports.
When a country's export prices rise relative to its import prices, its terms of trade improve. It can buy more imports for the same volume of exports, which raises national income. When export prices fall relative to import prices, its terms of trade worsen.
The terms of trade index is calculated by dividing an index of export prices by an index of import prices and multiplying by 100. For example, if export prices rise to 110 while import prices stay at 100, the terms of trade index is 110, a 10% improvement.
Changes in the terms of trade are especially important for countries that export commodities. When prices of oil, metals or farm products rise, exporting countries such as Australia, Chile or Saudi Arabia benefit, while commodity importers may be hurt.
The terms of trade affect exchange rates, government revenues, incomes and investment. Sharp swings can create booms and busts in commodity-dependent economies.
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