Theory question 102
International TradeThe terms of trade position for Country X for the years 2020 and 2021 are stated in table 1 below. Study the table and answer the questions that follow.
Year | Price index of exports | Price index of imports
2020 | 180 | 150
2021 | 160 | 200
(a) Calculate the terms of trade for Country X in 2020 and 2021.
(b) In what year(s) is the terms of trade: (i) favourable; (ii) unfavourable? Give a reason for your answer in each case.
(c) State any two likely reasons for the terms of trade position identified in 2(b)(ii).
(d) If the balance of trade in 2022 is $4,062,500 and the current account balance is $812,500, determine the country's balance of invisible trade. Explain your answer.
Show the model answer
(a) 2020: 180/150 × 100 = 120; 2021: 160/200 × 100 = 80.
(b)(i) Favourable in 2020: the figure (120) is above 100, so export prices are high relative to import prices and each unit of exports buys more imports.
(ii) Unfavourable in 2021: the figure (80) is below 100, so export prices are low relative to import prices.
(c) Any two: fall in world prices of the country's (primary) exports; rise in prices of imported manufactured goods; imported inflation; fall in demand for the exports; poor quality of exports; devaluation of the currency.
(d) Current account = balance of trade + invisible balance, so invisible balance = 812,500 − 4,062,500 = −$3,250,000: a deficit, meaning the country pays more for services from abroad than it earns from services sold abroad.
Terms of trade above 100 is favourable; below 100 is unfavourable.