Meaning and Significance of Terms of Trade
Meaning and Significance of Terms of trade
Meaning of Terms of Trade
By "terms of trade", we mean the terms at which two countries trade with each other. It refers to the value of a country's exports which have to be given in exchange for its imports. It indicates the rates at which a country exchanges its own goods for those of another. If trade between two countries is such that one is specializing in agricultural production and the other in manufactures, the trade is not advantageous to the former. We might then say that the terms of trade are moving against that country or they are not favorable to it. Similarly, if a country is exporting minerals in a raw state and other raw materials, the terms of trade are unfavorable to it. Within the limits set by the ratios of comparative costs, the actual rate of exchange of domestic goods for foreign goods will depend upon relative intensities of reciprocal demand, i.e., country A's demand for B's goods and B's demand for A's goods.
The terms of trade can be put in the form of equation as under:
Terms of trade = Value of imports/ Value of exports
=Price of imports X volume of imports/ Price of exports X volume of exports
If the volumes of imports and exports remain unaltered, then the terms of trade will be indicated by the fraction--
Price of imports/ Price of exports
In order to understand how the terms of trade may have changed over a period, an index number of imports and exports may be prepared. One year may be taken as the base year (= 100) and the index of a subsequent year may be worked out. This will give a new fraction which will show how the terms of trade have moved as between two countries.
Significance of Terms of trade
The terms of trade are of great economic significance to a country since they determine the gain that accrues to a country from international trade. If terms of trade move in a country's favor, it will increase gain from its international trade and raise in it the level of incomes. It will be quite the reverse in a country for which the terms of trade become adverse. Suppose an agricultural, revolution takes place in countries which are markets for our agricultural goods. The result will be that our goods will no longer be in demand or demand for them will be greatly reduced. The growers will suffer and their incomes will fall.