Effect of the Terms in import export business
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The import and the export prices of a country is called Terms Of Trade or TOT. In other words, TOT is a relationship between the prices at which a particular country sells its imports and the price at which it buys the exports. For each unit of goods exported, if a country receives more imports, it is said that the terms of trade are working in the favour of that country. In other words, if the prices of the exports of a country rises in comparison to the prices of its imports, the terms of trade is said to have been moved in the favourable direction. Terms Of Trade is an integral part of all the import export courses online so we will be discussing it in brief here.
How exactly does Terms of Trade work?
The TOT is employed as a gauge of a country’s economic health, although it has the potential to lead experts astray. Changes in import and export prices have an impact on the TOT, thus it’s critical to understand what caused the price to rise or fall. For economic monitoring, TOT measurements are frequently recorded in an index.
When a country’s TOT improves or increases, it usually means that export prices have increased while import prices have remained stable or decreased. Export prices, on the other hand, may have decreased, but not as much as import prices. Export prices may have remained stable while import prices fell, or they may have simply risen faster than import prices. All of these events could lead to a higher TOT.
Terms of trade effect
As we have discussed the favourable conditions of TOT, in the same way if the import price of a country rises in comparison to export prices, it is said the terms of trade has been unfavourable for that country or has deteriorated. Both the favourable and deterioration in the terms of trade leaves an impact on the living standards of people of that country. In favourable TOT, the living standards of people tend to significantly improve as the imported goods appear cheaper to buyers. Opposite to that. When the TOT deteriorates the living standards of people of the country are adversely affected as the imported goods seem expensive to the consumer while the foriegn currency earnings are comparatively less.
If the currency value falls, an increase in the price of exports is expected while the domestic price of exports remains unchanged when the devaluation happens. This is the reason why a deterioration is expected in the terms of trade after devaluation. Similarly, when it comes to appreciation, the imports become cheaper and the exports become costlier so an improvement in terms of trade is usually expected in this scenario.
Factors affecting the terms of trade
Some of the factors that affect the terms of trade are discussed below
- The appreciation or decline in the exchange rate affects the terms of trade as the exchange rate is responsible for making imports and exports cheaper or costlier in the country
- The cost of raw materials and the productivity of firms affect the export price thus affecting the terms of trade as well
- Inflation rates in different countries also affect the terms of trades. The effect might be temporary but some effect will definitely be observed. For example, higher inflation would lead to the rise in export prices that will temporarily affect the terms of trade.
- Firms will never make the prices down for the goods whose prices got slashed due to devaluation because they do not want to compromise with the profit margin. So, exchange rates might possibly not affect the terms of trade
