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Lesson 2 - HL
Learning outcomes:
Explain how changes in the Terms of Trade in the long term may result in a
redistribution of income.
Examine the effects of changes in the Terms of Trade on a countrys current
account, using the concept of PED for imports and exports.
Changes in Demand
Change in Demand influences the Terms of Trade & Current Account move in the
same directions.
Increase Demand - Improved Terms of Trade - Current Account moves to surplus
Changes in Supply
Depends on PED
PED > 1 - Elastic
Decrease Supply - Increase in Price
-Decrease in Total Revenue
Loss in Total Export Revenue
Current Account moves towards deficit
PED < 1 - Inelastic
Decrease Supply - Increase Price - Increase
in Total Revenue
Increase in Total Export Revenue
Current Account moves toward surplus
http://thismatter.com/economics/imag
es/elastic-inelastic-time-diagrams.png
Domestic Inflation
https://upload.wikimedia.org/wikipedia/commons/t
humb/1/1c/Price_elasticity_of_demand_and_reve
nue.svg/220px-Price_elasticity_of_demand_and_
revenue.svg.png
Domestic Inflation
LDC Countries selling commodities (low PED) - increased domestic
inflation should be good news
Improve Terms of Trade and Trade Balance
However, LDC Countries cannot sell commodities at a higher price
worldwide
A lot of substitutes in the Global Market - leaves little room for LDC
countries to increase prices
LDC countries have good reason to keep Domestic Inflation under
control
Depreciation
Exports become less expensive
Imports more expensive
Deterioration in the Terms of Trade
Appreciation
Exports become more expensive
Imports less expensive
Improvement in Terms of Trade
Change in Trade Balance (Exports - Imports)
Depends on the Price Elasticity of Demand - consumers sensitivity to
changes in price.
Depreciation
Exports cheaper - Deterioration in Terms of Trade
Trade Balance - PED
PED > 1 for Exports + Imports
Consumers are more sensitive to a change in price
Exports cheaper - % price decrease is less than % Quantity
increase
Exports Revenue increases
Improve Balance of Trade - moves towards surplus
PED < 1 for Exports + Imports
Consumers are less sensitive to changes in price
Exports cheaper - % price decrease is greater than % Quantity
increase
Export Revenues decrease
Worsening Balance of Trade - moves towards deficit
Appreciation
Exports more expensive - Improvement in Terms of Trade
Trade Balance - PED
PED > 1 - consumers are more responsive to a change in price
Exports more expensive - % increase in price is less than the %
decrease in Quantity
Export Revenues decrease
Worsening Trade Balance - moves towards deficit
PED < 1 - consumers are less sensitive to change in price
Exports more expensive - % increase in price is greater than the %
decrease in Quantity
Export Revenues increase
Improvement in the Trade Balance - moves toward surplus
Depreciation
Appreciation
Deterioration
Terms of
Trade
Improvement
in Terms of
Trade
PED (X - M)
Elastic
Improvement
in Trade
Balance
PED (X - M)
Inelastic
Worsening of
Trade
Balance
PED (X - M)
Elastic
Worsening of
Trade
Balance
PED (X - M)
Inelastic
Improvement
in Trade
Balance