The terms of trade: calculation and causes

Calculating the terms of trade

Terms of trade = (index of average export prices / index of average import prices) x 100

In the base year both indices are 100, so the terms of trade are 100.

• Above 100 or rising: an improvement (favourable movement); each unit of exports buys more imports.
• Falling: a deterioration (unfavourable movement).

'Improvement' only describes prices; it may not be good for the economy, as the next lesson shows.

Terms of trade improve in year 2 and deteriorate in year 3

Influences on the terms of trade

• Relative inflation rates: higher inflation at home raises export prices relative to import prices (improvement in the short run).
• Productivity and labour costs: rising productivity lowers unit costs and export prices (deterioration), though it raises competitiveness.
• Exchange rates: an appreciation raises export prices in foreign currency and lowers import prices in domestic currency, so the terms of trade improve; a depreciation worsens them.
• Import and export prices directly: for example, a rise in world oil prices improves the terms of trade of oil exporters and worsens those of oil importers. Changes in world demand and supply of commodities are a major cause.
• Long run: the Prebisch-Singer hypothesis argues that prices of primary products tend to fall relative to manufactures over time, so commodity exporters' terms of trade tend to deteriorate (covered under development).

Percentage change

Percentage change in terms of trade = (new - old) / old x 100. Be careful: the change from 100 to 95 is a 5% fall, but from 95 back to 100 is a 5.26% rise. Exam calculations usually want 2 decimal places.

Worked example

Export prices rise by 8% and import prices rise by 20% from a base year. Calculate the new terms of trade.

1. Export index = 108; import index = 120
2. 108 / 120 x 100 = 90

Answer: 90: a deterioration of 10%

Check yourself

1. The export price index is 115 and the import price index is 92. Calculate the terms of trade.
   Show answer

   125. 115 / 92 x 100 = 125.

2. The export price index is 96 and the import price index is 108. Calculate the terms of trade to 2 decimal places.
   Show answer

   88.89. 96 / 108 x 100 = 88.89.

3. The terms of trade fall from 104 to 91. Calculate the percentage change to 2 decimal places (negative for a fall).
   Show answer

   -12.50 %. (91 - 104) / 104 x 100 = -12.50%.

4. The terms of trade are 120 and the import price index is 105. Calculate the export price index.
   Show answer

   126. Export index = 120 x 105 / 100 = 126.

5. An appreciation of a country's currency will, other things equal,
   • worsen its terms of trade
   • improve its terms of trade
   • leave its terms of trade unchanged
   • raise its import prices in domestic currency
   Show answer

   improve its terms of trade. Export prices in foreign currency rise and import prices in domestic currency fall.

6. A large rise in world oil prices is most likely to worsen the terms of trade of
   • a major oil exporter
   • a country with no trade
   • every country equally
   • a country that imports most of its oil
   Show answer

   a country that imports most of its oil. Its import price index rises relative to its export prices.

7. Explain why faster productivity growth can lead to a deterioration in a country's terms of trade.
   Show answer

   Higher productivity lowers unit labour costs, so firms can cut export prices; export prices fall relative to import prices, so the terms of trade worsen (even though competitiveness improves).. Lower costs pass through to lower export prices.

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Sources

• Pearson Edexcel International Advanced Level in Economics specification (issue 2)

Last updated 8 November 2026. Spotted a mistake? Tell us.