termsoftrade

Terms of trade (TOT) is a ratio that compares a country’s export prices to its import prices, typically expressed as an index. It is often defined as TOT = (export price index / import price index) × 100. A TOT above 100 means export prices rise relative to import prices, giving the country more importable goods per unit of export revenue; TOT below 100 implies the opposite.

TOT can be measured in terms of domestic currency or in real terms, and can be calculated from price indices for exports and imports or weighted by export volumes. It is a relative price measure rather than a direct welfare indicator; changes in TOT affect national income through price effects on trade, but welfare also depends on trade volumes, terms of demand, and other real factors.

Limitations include that TOT ignores quantities traded and can be distorted by changes in the composition of a country’s exports and imports. Exchange rate movements, price volatility, and shifts in global demand can influence TOT independently of a country’s overall welfare. There are multiple definitions, such as commodity terms of trade (based on export commodity prices) and income or real terms of trade (which adjust for changes in export volumes). A deterioration in TOT does not automatically reduce welfare if export volumes or world prices shift in a favorable way.

Applications: economists use TOT to assess external-sector health, study the impact of price shocks, and compare competitiveness across countries. It remains a central concept in macroeconomic and international-trade analysis.