terms of trade
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Terms of trade
Terms of Trade
2. In international trade, the difference between price indices on imports and exports.
3. See: Balance of trade.
terms of tradea PRICE INDEX that shows a country's EXPORT prices relative to its IMPORT prices. It is constructed by taking an index of prices received for exports, on the one hand, and an index of prices paid for imports, on the other, and then dividing the first by the second (see Fig. 183 ). An improvement in a country's terms of trade occurs if its export prices rise at a faster rate than import prices over time and a worsening of the terms of trade if export prices rise more slowly than import prices; or, vice-versa, if export prices fall at a slower rate than import prices (as in Fig. 183), then the terms of trade are improved.
Superficially, an improvement in a country's terms of trade may be considered to be beneficial: in foreign-exchange terms, a given amount of exports will now finance the purchase of a greater amount of imports, or, put another way, a given amount of imports can now be purchased for a smaller amount of exports. A critical factor in this regard, however, is the PRICE- ELASTICITY OF DEMAND for exports and imports. If, for example, export demand is price-elastic, then price rises (which make the country's exports less competitive in world markets) will result in a more than proportionate fall in export volume, thus lowering foreign-exchange receipts and adversely affecting domestic output and employment. See also BALANCE OF PAYMENTS EQUILIBRIUM, DEVALUATION, REVALUATION.