Economics terms of trade

However, an earlier version of the concept can be traced back to the English economist Robert Torrens and his book The Budget: Definition[ edit ] Terms of trade TOT is a measure of how much imports an economy can get for a unit of exported goods. For example, if an economy is only exporting apples and only importing oranges, then the terms of trade are simply the price of apples divided by the price of oranges — in other words, how many oranges can be obtained for a unit of apples.

Economics terms of trade

Significance Net trade with foreigners: A trade deficit means that exports are insufficient to pay for exports; a trade surplus, the opposite. Sometimes called "net exports", the trade balance is a component of GDPto the effect that a perfectly equilibrated trade balance makes the GDP dependent only on domestic values consumptionpublic expenditureinvestments.

A simultaneous increase of both imports and exports by the same amount leaves unaltered the trade balance. Any difference in dynamics between exports and imports has a multiplied effect on trade balance. Composition Trade balance is usually decomposed by product and by country bilateral trade balances.

Relevant is the degree of concentration of the imbalance in trade caused by one or few commodities. If concentration is high, a targeted industrial policy could improve the balance e. On the other hand, if a deficit is due only to few partners, proactive and consensus-based trade negotiations with them could fairly quickly set the problem.

Although less general than trade balance, which includes both goods and services, the "merchandise balance", which includes only goods and not services, is sometime used because of better data availability. Determinants Convergent or divergent dynamics of imports and exports are the first causes of trade balance changes.

Everything that impact asymmetrically on imports and exports can impact the trade balance.

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In particular price and non-price competitiveness is relevant. If external pressure forces down the prices at which a country sells its exports, than a trade deficit is more likely "terms of trade" effect. In other words, in a hierarchical worldtrade balance can reflect political balance of power.

Currency reak exchange rate can be very important: A sharp devaluation can dramatically improve all these relationships. If financial transaction are particularly intensive and autonomous, an inflow of FDI can lead to higher imports of production inputs for the new foreign-owned plantsalso because of revaluation of currency.

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Hopefully, this short-run effect will be balanced by more exports in the future. In this cases, trade balance is adjusting to financial movements. Impact on other variables Trade balance is a component of GDP: If this impact is strong enough, it gives rise to the traditional Keynesian multiplier effect with consumption moving in the same direction.

In financial terms, trade balance influence the total size and the composition of the current-account balance and, more broadly, it influences the balance of payments which comprehends not only the trade balance but also income payments, loans and aid from abroad, etc.

In particular, long-lasting trade deficit can lead to foreign debt, on which a country has to pay interests. If this debt is judged by market agents as unsustainable, a currency crises can erupt.

Calculation of Term of Trade (With Formula)

Even before that this perspective materialises, the government can be induced to dampen GDP growth. Long-term trends Trade imbalances are widespread throughout the world and persistent over time.

In order to reduce the gap with rich countries, poor countries have to rise much faster than them, which are usually their main commercial partners.

Economics terms of trade

But this leads to trade deficit, which risks to jeopardize growth with alternate phases of "stop-and-go". Business cycle behaviour Trade balance tend to be strongly anti-cyclical: The reasons are explained in depth here and here.Economics Social Studies Georgia Performance Standards.

Free trade: Free trade, a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports).

A free-trade policy does not necessarily imply, however, that a country abandons all control and taxation of imports and exports. This is the simplest yardstick of economic performance.

If one person, firm or country can produce more of something with the same amount of effort and resources, they have an absolute advantage. The Economist offers authoritative insight and opinion on international news, politics, business, finance, science, technology and the connections between them.

The Theory of Comparative Advantage - Overview. Historical Overview. The theory of comparative advantage is perhaps the most important concept in international trade theory. About fifteen Economics departments claim to be top ten* in the world. In that elite group, we're the new kids.

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