Chapter 4: Terms of Trade

Concepts

HG Manur

and Significance

Terms of Trade
Significance:

a) The gains from Trade depends on it

b) Third World nations feel that their

products have suffered a

secular deterioration in their terms of trade as a result of which
there has been an unjust transfer of income to rich countries
who have improved their terms of trade at the expense of poor
nations terms of trade

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Terms of Trade
Types of Terms of Trade:

1. Gross Barter Terms of Trade

2. Net Barter or Commodity Terms of Trade
3. Income Terms of Trade
4. Single Factorial Terms of Trade
5. Double Factorial Terms of Trade
6. Real Cost Terms of Trade
7. Utility Terms of Trade

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Gross Barter Terms of Trade

Developed by Taussig in 1927.
Symbolically,
G= Mq/Xq*100
G= Gross Barter Terms of Trade
Mq= import quantity index
Xq = export quantity index
Increasing ratio indicate improved terms of trade and decreasing
ratio indicates deteriorating terms of trade.
Limitations:
Its not commonly used methods because of difficulty in
calculating the ratio in terms of quantity
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Net Barter or Commodity Terms of Trade

This is the most universally used methods
Symbolically,
N= Xp/Mp*100
N= Net Barter or Commodity Terms of Trade
Xp= Price index numbers of export
Mp= Price index numbers of imports
Limitations:
Fails to capture the export earnings rather capture only how high
is export price and import price. Besides price, export earnings
depends on the elasticity of concerned goods too.
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Net Barter or Commodity Terms of Trade

The higher the elasticity the higher export earning due to
increases in price by a small amount and vice versa

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Income Terms of Trade

Developed by G.S Dorrance in 1948-49
Symbolically,
I= N. Xq= Xp/Mp * Xq
I= Income Terms of Trade
N= Xp/Mp
Xp= Price index numbers of export
Mp= Price index numbers of imports
Xq= export quantity index

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Income Terms of Trade

Limitations: It is a supplement but by no means a replacement
of concept of commodity terms of trade.
Fails to capture the changes in Productivity for export
producing goods.

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Single Factorial Terms of Trade

Developed by Jacob Viner in 1937 to capture the export
productivity growth.
Symbolically,
S= N. Xz= Xp/Mp * Xz
N= Xp/Mp
Xp= Price index numbers of export
Mp= Price index numbers of imports
Xz= export productivity index
Limitations: Fails to capture import productivity

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Double Factorial Terms of Trade

When the commodity terms of trade are corrected for both
productivity gain export and import then this methods comes
up.
Symbolically,
D= N. Xz/Mz = Xp/Mp * Xz/Mz
N= Xp/Mp
Xp= Price index numbers of export
Mp= Price index numbers of imports
Xz= export productivity index
Mz= import productivity index
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Double Factorial Terms of Trade

Limitations : Fails to capture real cost

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Real Cost Terms of Trade

R= N. Xz/Xr= Xp/Mp * Xz/Xr
N= Xp/Mp
Xp= Price index numbers of export
Mp= Price index numbers of imports
Xz= export productivity indexX
Xr= Real cost index of producing export goods
Fails to capture the utility terms of trade ( foregone utility)

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Utility Terms of Trade

Developed by D.H. Robertson,
U = N. (Xz/ Xr. ). 1/Um
N= Xp/Mp
Xp= Price index numbers of export
Mp= Price index numbers of imports
Xz= export productivity index
Xr= Real cost index of producing export goods
Um= domestic goods whose consumption is forgone because of
the use of resources in export production

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