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Terms of Trade vs. Balance of Trade: Which Matters More?

Question

Explain the difference between the terms of trade and the balance of trade in goods and consider whether an economy should be more concerned about its terms of trade than its balance of trade in goods.

Category:

International Trade and Exchange Rates

AS Level Cambridge 2023 Paper 22

Preview Answer

The term of trade is a numerical measure of the relationship/ratio between export and import prices, with an accurate formula showing the measure as an index , whereas the balance of trade in goods measures the revenue earned from exports of goods minus the expenditure on imports of goods .

Analysis must consider issues concerning both the terms of trade and the balance of trade in goods. These may include:

• an analysis of the effects of changes to the terms of trade e.g., relative change in competitiveness, increase in cost-push inflation, effects on balance of trade in goods and services.

• an analysis of the effects of changes to the balance of trade e.g., an increase in the demand for exports ceteris paribus may lead to an increase in the balance of trade, impact on employment levels, economic growth, inflation.

Evaluation should use relevant analysis to consider the importance of both measures and make a judgement as to which one may be of most concern to an economy . Reserve one mark for a justified conclusion .

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