In the field of international trade, ‘terms of trade’ refer to the rate at which country’s exports exchange for its imports. Generally, the prices of the commodities to be exported and imported influence the exports and imports of the two countries. They indicate the relationship between the prices of exports and imports of a country. There are some factors Influencing Terms Of Trade which are discussed as follows:
Factors Influencing Terms Of Trade In Developing Countries:
1. Elasticity of Demand and Supply in two Countries. Generally, the terms of trade depend upon the ‘reciprocal demand’ for goods i.e., the demand and supply of one country’s goods in the other country and other country’s goods in this country due to change in prices. In other words, elasticity of demand and supply in two countries govern the – terms of trade. These elasticity is of four types—
- Elasticity of a country’s demand for imports,
- Elasticity of foreign country’s demand for exports,
- Elasticity of the supply of the country’s exports, and
- Elasticity of the supply, of country’s imports (or foreign country’s exports). Any change in any of the elasticity will cause change in the terms of trade of the country concerned.
2. Changes in the Demand. If there is a change in the demand for imports and exports, the relativity of imports and exports will also change i.e., terms of trade will change. If demand for country’s imports increases, it means the prices for imports will also go up and the terms of trade will turn against that country, because in such circumstances, the country will have to part with more exports for a given quantity of imports. On the contrary if the demand for exports increases, it means, the prices of exports will go high and the terms of trade will be favorable to that country because the country will have to part with less quantity of exports for the same quantity of imports.
3. Devaluation : Devaluation implies the lowering of exchange rate of domestic currency in terms of other currencies. It means, the imports will be dearer and exports cheaper. It may result in an improvement or deterioration in the terms of trade of the country which devalues its currency depending upon the elasticity of demand and supply of the commodities entering the foreign trade. If the product of the demand elasticity for the country’s imports and exports is greater than the product of supply elasticity of country’s imports and exports, the terms of trade will be favorable otherwise it will be unfavorable or deteriorated.
4. Tariffs: Imposition of tariff duties and tariff restrictions has the effect of registering an improvement in the terms of trade of a country. The reason being that tariff duties and restrictions reduce the country’s’ imports ‘and increase the country’s exports. As a result, a given quantity of exports now fetches a larger quantity of imports than before and thus registering an improvement in the country’s terms of trade.
5. Substitutes : Existence of a close substitute of the commodity in the international market, also affect the terms of trade. If commodities exported of a country have no close substitutes in the foreign market, the terms of trade will be favorable. Because in such cases, the, country’s exports can fetch relatively higher prices abroad. In case of, availability of close substitute in the international market, the exports, will fetch relatively lower prices and therefore, the terms of trade will turn against the country. Similarly, if imported goods-have close substitutes in the country’s market, the imports will be lower and terms of trade will be favorable or in case of non-availability of substitutes in the local market will turn the terms of trade unfavorable.
6. Economic Structure. The economic structure of the country i.e., commodities entering into international trade also influence the terms of trade. If the country produces and exports agricultural raw materials and food grains, the terms, of trade will be against that country because the prices of agricultural goods have shown a declining tendency in the past few decades. A country producing exporting industrial goods, on the contrary, will tend to have favorable terms of trade because the demand and prices for industrial goods have registered an increase in the international markets.
7. Economic Development. Economic development of a country may possible have two effects on the terms of trade (i) income effect, or demand effect and (ii) supply effect.
Due to economic development, the income per capita of the country will increase and therefore, the demand for more goods will also register an increasing. It will lead to more demand for imported goods. Moreover, the economic development may lead to an increase in the output possibly of those goods which are otherwise imported from foreign countries. It will reduce imports and push up exports. This may be known as supply effect. These two effects combined will influence the terms of trade of the country. If demand effect is more powerful than the supply effect, the terms of trade will turn against the country. Contrarily if the supply effect is more powerful, the terms of trade will be favorable.