Question

Discuss the determinants of terms of trade with example.   

Answer 1

Terms of Trade is simply an indicator for the ecconomic growth of a country.Terms of Trade is the ratio of export prices to import prices.When the export of a country is more than its import then it can be said that a country is in favourable stage.Terms of trade gives an understanding about the situation of export and import.

The determinants of terms of trade are as follows:

1.Change in taste and preferences- Terms of trade depends on the taste and preferences of consumers.When there is change in the preferability of a consumer, or when a consumer shifts his preference to some other commodity ,then terms of trade gets influenced.

For Example: Country A exports tea to country B and country B exports coffee to country A If country Bs tastes shift from tea to coffee ,then country B will not import more of tea but rather produce more coffee. So country B will be benefitted as its import will get reduced.

2. Scarcity - scarcity is also an imprtant factor for terms of trade. If a seller has more goods then he will sell more and similarly will buy more goods from that sales revenue.

For Example: If country A is producing more tea in comparison to Country Bs coffee then it can export more of tea and can gain more in comparison to country B.

3. Reciprocal demand - By reciprocal demand we mean the elasticity of demand and the relative strength of two trading countries.Lets take an example:

Suppose country A exports cotton to country B and imports wheat from country B and the demand for wheat is inelastic,then country A will be prepared to give more of a cotton to country B for a given amount of wheat.So in this situation the terms of trade is not favourable for A.

On the contrary, if demand for wheat is elastic,then country A will be preapred to give less cotton to country B for a given amount of wheat. In this case, situation is favourable for country A.

4. Tariff - Imposition of tariff also affects the terms of trade .It has been said that the imposition of duties not only provides help to industries but can also help a country to get its import cheaper.

Suppose, the demand for the import of country A is elastic, as a result of the impostion of tariff import declines as the price of imported items rises.When there is a decline in imported items then it effects the export earnings of its trading partner as the demand for its exported products reduces.As a result its export earnings reduces,so to maintain its export earnings ,the trading partner reduces the price of its exports.This means that the tariff imposed country will now get its import at a lower price.

5.Quality - the terms of trade also depends on the quality of any product.The products which are more liked by the consumers or whose quality is better will be exported more .Similarly high quality goods will cost more and if the seller sells more then he can earn additional capital from it.

6.Economic growth: Economic growth is another important determinant of terms of trade.Increase in the income and national product of a country is an indicator of economic growth of a country.Economic growth means the increase in the production capability of a country. The  increase in production or improvement in th production process can favourably affect the country's export . With more efficient production the country can gain in terms of trade.

These are the determinants of terms of trade.When the export earrnings are more, then we can say that a country is having favourable terms of trade.Terms of trade is an indicator for a country's growth prospect.It is calculated by dividing the price of exports to price of imports ,multiplied by 100.