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Terms of Trade and The Balance of Payments

The document discusses terms of trade and the balance of payments. It provides examples of how changes in terms of trade and exchange rates can impact a country's current account balance. A deterioration in terms of trade for a country that relies heavily on primary exports would negatively impact its current account balance and potentially cause issues like higher inflation. Long-term declines in terms of trade can also lead to global redistributions of income as prices of goods between countries adjust.

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55 views2 pages

Terms of Trade and The Balance of Payments

The document discusses terms of trade and the balance of payments. It provides examples of how changes in terms of trade and exchange rates can impact a country's current account balance. A deterioration in terms of trade for a country that relies heavily on primary exports would negatively impact its current account balance and potentially cause issues like higher inflation. Long-term declines in terms of trade can also lead to global redistributions of income as prices of goods between countries adjust.

Uploaded by

k_oonn
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Terms of Trade and Balance of Payments

Terms of Trade and the Balance of Payments


1. The table below gives imports and export price indices for Country A. Calculate the terms of trade index for each year and state whether the
TOT have improved or deteriorated
Year Import price
index
export price index terms of trade index improved/
deteriorated
2005 100 100
2006 120 110
2007 130 120
2008 140 130
2009 150 145
2. How will deterioration in the terms of trade of Country A affect its current account balance? Explain why this might be so.
3. Assume that country As exports consist of 70% primary products. Discuss at least three problems that might arise from the deterioration in the
countrys terms of trade.
Exchange rates and the Balance of Payments
4. Assume the UK balance of payments on current account is in deficit.
4a) A depreciation of the UK pound against all other currencies causes import prices to increase by 15% and export prices to fall by 12%. The
price elasticity of demand for imports is 0.35 and the price elasticity of demand for exports is 1.25 (long-run elasticity).
4b) Now consider the following elasticity of demand: for exports: 0.3 , and for imports: 0.4 (short-run elasticity).
Using the concept of PED and the values above, explain how this will affect the UK current account on the Balance of Payments.

5a) An appreciation of the UK pound against all other currencies causes import prices to fall by 6%, and export prices to rise by 10%. The price
elasticity of demand for exports is 2.6, and the price elasticity of demand for imports is 0.4 (long-run elasticities).
5b) Now consider the following elasticities of demand: for exports: 0.5; for imports: 0.4 ( short-run elasticities).
Using the concept of PED and the values above, explain how this will affect the UK current account on the Balance of Payments.

6. The fall in the value of the pound is causing concerns in the UK that inflation might accelerate. Explain why this might be a concern.

7. Explain how long-term changes in the terms of trade may result in a global redistribution of income.

8. Using the concepts of specialization, PED and YED, explain the impacts of short-term fluctuations and long-term deterioration in the terms of
trade of economically less developed countries that produce mainly primary commodities.

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