Terms of Trade
About the calculation
Terms of Trade is an index which provides a measure of relative movements in prices for Australia's exports, compared to the price received for imports. Where the index increases, the terms of trade is said to strengthen. Where the index decreases, the terms of trade is said to deteriorate.
The TOT is a measure of the relative prices of exports to imports in the form of an index calculated against a base year.
It is export price index divided by import price index.
Terms of trade index = Export price index/Import price index x 100
When the terms of trade improves (increased export prices relative to import prices) a nation is better off, as it can buy more imports with the same level of exports. A worsening of the terms of trade means a nation must sell more exports to purchase the same quantity of imports.
So, good terms of trade – index of 140. Bad terms of trade, 90.
An index of 100 means that the relative prices of imports and exports are the same as the base year. >100 means that exports are proportionally more expensive, <100 means that imports are proportionally more expensive.
How is it examined?
Typically multi-choice or short answer but it could form a useful part of an essay on external stability or trade/globalisation.Whilst the TOT is not typically required to be calculated, it is often a concept in multiple choice questions where the export and import indexes may be provided.
What students get wrong
Common errors include:
- thinking TOT is amount of goods (ie volume) rather than price
- thinking TOT is import price index / export price index
- thinking TOT is the value of goods rather than prices of the goods