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It is a measure of the amount of imports that can be exchanged per unit of exports. Assume that Finland and Russia trade only mobile phones (Finland) and caviar (Russia):
One mob phone = USD 300 One hectogram caviar = USD 100 ToT Finland = 300/100 = 3 One phone buys 3 hectograms caviar ToT Russia = 100/300 = 0.33 One hect caviar will buy 0.33 mob phones.
Suppose price of caviar to USD 200: ToT Fin = 300/200 = 1.5 () Deterioration of ToT ToT Rus = 200/300 = 0.66 () Improvement of ToT The distribution of global output has changed in favour of Russia, which can now get more imports for a given amount of exports (or the same quantity of imports for a smaller amount of exports). We then say that Russias ToT have improved. The opposite holds for Finland, which can now get fewer imports for the same amount of exports. Finlands ToT have deteriorated.
Therefore, a change in ToT resulting from a change in PM(PX) will affect the value of imports (value of exports).
Imports:
Elastic Demand (PED>1): P M exp, P M exp Inelastic Demand (PED<1): P M exp, P M exp
Exports:
Elastic Demand (PED>1): P X rev, P X rev Inelastic Demand (PED<1): P X rev, P X rev
Most manufactured goods are price elastic, so technology advances do not pose a problem and a lower price increases international competitiveness Many primary (dus including agricultural) products are price inelastic. For exporters technology advances or productivity increases may lead to X Rev and worsening of CA
Therefore:
If PED < 1 X Rev Improvement of CA If PED > 1 X Rev Worsening of CA
Benefits of cost-push inflation will be only shortterm, as Gov will counteract negative effects in the economy (inflation and recession) with monetary and fiscal policies.
However, oil exporters which restrict their S of oil benefit from long lasting effects on their CA, as oil has a low PED for exports (P X Rev). In particular, OPEC countries have accumulated large surplusus in their CA. On the contrary, oil importers have a low PED for imports of oil: P M Exp
Long term improvements in ToT redistribute global output and income towards the country experiencing the improvement. This allows increased investment and increased imports of capital goods, which can have a positive impact on economic growth. Impacts within the domestic economy:
If increase in X prices: it is likely to be lasting if caused by a long-term increase in D for X. This will favour technological change, increased employment and greater investment. If decrease in M prices: will impact consumers and firms (lower prices in consumer or capital goods)
Long-term deterioration in ToT redistributes global output and income away from the country experiencing the deterioration. Increasing quantitites of exports are needed in order to maintain a certain amount of imports. Reduces possibilities for investment and diminishes the quantity of imports needed for production Empirical research shows that developing countries which are non-oil commodities exporters have experienced deteriorating ToT over long periods of time.
Figure 1 - A. Real agricultural commodity price trends (1980 = 100) (deflated by the price index of manufactured exports of industrial economies)
On average, prices of key agricultural commodites fell by 50% between 1980 and 2000.
In the case of certain products, including sugar and cotton the fall has been even greater.
Food has a low PED Some non-food primary products (rubber, cotton) face competition from synthetic alternatives, leading to low YED for these products, which puts downward pressure on the prices.
2. Technological advances in agriculture. Slow demand growth and increased supply have caused prices to decrease even further. 3. Protection of agriculture in DCs. In order to protect farmers income, governments in DCs:
impose tariff and other trade barriers on imports of agricultural commodities, which restricts world D for protected agricultural products grant export subsidies, which increase world supply Effect is p.