Answer to Question #292795 in Economics for Hafsa

Question

What do the terms of trade measure? What is the relationship between the terms of trade in a world of two trading nations? How are the terms of trade measured in a world of more than two traded commodities?

Answer 1

Terms of trade are defined as the ratio between the index of export prices and the index of import prices. If the export prices increase more than the import prices, a country has a positive terms of trade, as for the same amount of exports, it can purchase more imports.

Since in a two-nation world, the exports of a nation are the imports of its trade partner, the terms of trade of the latter are equal to the inverse, or reciprocal, of the terms of trade of the former.