What are Terms of Trade?
Terms of trade are the ratio of a country's export prices to its import prices. They show how much a country must export to afford the same amount of imports—a key measure of trade advantage. When a country's terms of trade improve, it can buy more imports with the same amount of exports.
Terms of trade (TOT) = Export price index / Import price index. A higher ratio means a country gets more favorable prices and greater purchasing power in world markets.
- •Export prices rise
- •Import prices fall
- •Need less output to buy imports
- •Stronger bargaining power
- •Export prices fall
- •Import prices rise
- •Need more output to buy imports
- •Weaker bargaining power
Step-by-step worked examples
Country X exports oil at $80/barrel and imports grain at $200/ton. Exports are 100 barrels, imports are 50 tons. Calculate TOT.
Total export value = 100 × $80 = $8,000 Total import value = 50 × $200 = $10,000 TOT index = Export index / Import index (simple: 8,000 / 10,000 = 0.8) TOT = 0.8 or 80 — less favorable (need more exports per import unit)
Oil prices double to $160/barrel while grain stays $200/ton. What happens to TOT?
New export value = 100 × $160 = $16,000 Import value = $10,000 (unchanged) New TOT = 16,000 / 10,000 = 1.6 TOT improved from 0.8 to 1.6 — the country is better off.
A country's export prices fall 20%, import prices rise 10%. Roughly, TOT changes by…?
Export index: 100 × (1 - 0.20) = 80 Import index: 100 × (1 + 0.10) = 110 TOT = 80 / 110 ≈ 0.727 TOT deteriorated (fell from 1.0) — less favorable trade.
Flashcards
Quick quiz
Q1.Terms of trade (TOT) are…
Q2.If a country's TOT improves, it can…
Q3.Export prices rise 15%, import prices fall 5%. TOT has…
Q4.A country exporting oil faces volatile TOT because…
The full card deck, worked steps and AI-tutor support for “What are Terms of Trade?” are in Notek — study by hand before your exam.
Common mistakes
Improving TOT always means higher GDP growth. — Correct: Better prices help, but sustainable growth needs productivity gains, diversification, and investment.
TOT only affects commodity-exporting countries. — Correct: All countries trading goods are affected; it matters for any export-import relationship.
TOT is the same as the trade balance. — Correct: TOT is price ratios; trade balance is quantity (exports minus imports in value).
A country with TOT = 1 is in perfect equilibrium. — Correct: TOT = 1 just means prices are equal; countries can still run deficits or surpluses.
FAQ
What are terms of trade?
TOT is the ratio of export prices to import prices. A higher ratio means a country gets more favorable prices in international trade.
Why do terms of trade matter?
They determine a country's purchasing power in global markets. Improving TOT means the country can afford more imports with the same exports.
What causes terms of trade to change?
Changes in global commodity prices, exchange rates, supply shocks, and demand shifts—especially for primary product exporters.
Can a country improve its terms of trade?
Partly—by exporting higher-value products, diversifying exports, or improving technology. But global prices are often beyond a country's control.