In international economy, the terms of trade represent the Purchasing power of the Exportation S of a Pays in terms of Importation S. the index of the terms of trade more running measurement the relationship between the prices of exports and the prices of the imports. An increase in this index corresponds to an improvement of the terms of trade: for example, a country expensive sells its exports for a constant import price. Conversely, a reduction in the index corresponds to a degradation of the terms of trade.

The evolution of the terms of trade does not predict of anything the evolution of the commercial Balance, which reflects at the same time prices and volumes.

Presentation

The theory of the terms of trade is outlined by Thomas Malthus, then developed by Robert Torrens, James Pennington, Samuel Longfield, Nassau Senior and John Stuart Mill. It is an essential component to determine the interest of the reciprocity in international marketing policy.

The principle of the comparative Advantage stated by David Ricardo and Robert Torrens does not make it possible to determine with him only the prices and the quantities of exchanged goods. Ricardo considers that these reports/ratios are exogenic; Torrens on the contrary estimates that they are endogenous and seeks to determine under which conditions they can be handled. That led Torrens to formulate the theory of the optimal Customs duty: when a country is “large” and that it can dictate the price of its exports, it with the possibility of handling this price (by imposing a customs duty) to maximize its terms of trade.

Samuel Longfield indicates in 1835 how the terms of trade can vary according to the demand for importation of a country.

James Pennington shows into 1840 that the field of variation of the terms of trade is limited by the relationship between the relative costs of production which are used to calculate the comparative advantage: in the borderline case, one of the two countries sees all its profits with the exchange confiscated by the other.

Various measurements of the terms of trade

The ratio between price indexes is also called Nets terms of the exchange.

There exists rough terms of the exchange, which are the relationship between the quantum of imports and the quantum of exports. In the same way, an increase in this index corresponds to an improvement of the terms of trade: a country is obliged to produce a smaller volume to receive an equal volume.

Calculation of the terms of trade

Model with two goods and two countries

In the simplified case of two countries and two goods, the terms of trade are defined as the ratio of the price that one of the countries receives for its exported good, with that of the price which it pays for although it is important of the other country.

In this case, the imports of a country are by definition equal to exports of the other.

For example, if a country exports at a price of 100 euros a product in exchange of 50 euros for an imported product, the terms of trade for this country are 100/50 = 2. The terms of the other country are 50/100=1/2.

If, the following year, and with identical volumes, it exports at a price of 110 euros in exchange of 51 euros, the new terms are 110/51=2,16; the terms of trade thus increased by 7,8%.

General model

In the more realistic case of several countries exchanging several goods, the terms of trade are generally calculated by using the Indice of Laspeyres. the calculation of the terms of trade for a country will be the ratio of the index of Laspeyres of exports by the index of Laspeyres of the imports.

One thus has:

$\backslash \; tau^c\; =\; I\_x^c/I\_m^c$,

with:

$\backslash \; tau^c=\; \backslash ,$termes of the exchange (current period (c)),

$I\_x^c=$indice of Laspeyres of the prices the export (current period (c)), and

$I\_m^c=$indice of Laspeyres of the import prices (current period (c));

i.e.:

$\backslash \; tau^c=\; \backslash \; left/\backslash \; right.$,

with:

$p\_x^c=$prix of exports (current period (c)),

$q\_x^0=$ quantity of exports (basic period (0)),

$p\_x^0=$ price of exports (0),

$p\_m^c=$ price of the imports (c),

$q\_m^0=$ quantity of the imports (0), and

$p\_m^0=$ price of the imports (0).

With a table of comparison, one will be able to analyze the evolution of the terms of trade.

Determinants of the terms of trade

The factors likely to vary the terms of trade include/understand:

• preferences of the countries, their evolution, and uncertainty on these preferences;
• scarcity and characteristics of the exchanged goods (quality, apparent value, etc);
• production costs;
• foreign exchange rates and customs duties.

For example, a country which holds a rare and required good can expect favorable terms.

Terms of trade and balances commercial

The relation between a variation of the terms of trade and the evolution of the commercial Balance is indécidable a priori , and depends largely on the elasticity of the request in the short run then in the long run.

Empirically, one notes in general that a degradation of the terms of trade is accompanied initially by a degradation of the pay of the trade balance, then in the second time of an improvement of the balance; this evolution in two times is known under the name of “curve in J”.

See too

• Theory of the degradation of the terms of trade (thesis of Prebisch-Singer)

External bonds

• Definition INSEE
• Illustration of the index of the terms of trade on the site of the Canadian government (Ministry for Foreign Affairs and international business)

Sources

• Alain Beitone and Al , Dictionary of the economic scenes , Armand Colin, Paris, 2001, ISBN 2-200-26432-1, page 407
• Paul Krugman, Maurice Obstfeld, International Economics , 5^e edition, Addison-Wesley, ISBN 0-321-03387-6, chapter 5

• Steven Mr. Suranovic, International Economics - Determinants off the Terms off Trade , lira in line
• Douglas Irwin, Against the Tide: year Intellectual History off Free Trade , ISBN 0-691-05896-2
• Chi-Yuen Wu, Outline off International Price Theories , ISBN 041531366X, page 164

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