Terms of Trade

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Terms of trade refers to the measurement of a country’s export-prices with respect to its import prices, and is considered advantageous to the dual economies only in the case of it lying somewhere between the two production possibility frontiers. The measurement of terms of trade is specifically expressed through an index number by dividing the price for exports by the price for imports, only to ultimately multiply the answer by one hundred. This measurement helps an economy understand where it stands in terms of international trade and exchange rate, hence being of very beneficial value. Naturally, it is considered a favourable shift for a country if its export prices are rising much more in relation to import prices, meaning that, for every unit of exports sold, the country can buy more units of imported goods, hence drafting an improvement in the country’s terms of trade. Consequently, this creates a benefit in terms of how many goods need to be exported to buy a prearranged amount of imports. A favourable shift in a country’s terms of trade only takes place, in the short run, if demand and supply increase for the exported goods, if there is a change in the relative inflation rate, or if there’s a change in the exchange rates, and in the long run, if income changes or if the altitude of labour productivity modifies. In the case of any of these following changes, it is very likely that the terms of trade will be taken under an alteration with different repercussions. Firstly, in the scenario of an increase in demand, this will be very beneficial to the economy as it will sign of a warranty to an increase in the exporting country’s domestic profitability, which in turn, will assist with raising living standards in the economy. Additionally, an amplification in demand levels will also improve or enhance the current account balance due to the high prices of exports, hence leaving more money to be spent on imports. Secondly, in the case of an increase in the...
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