Copyright

Terms of Trade in Economics: Definition, Formula & Examples

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: Gains from Trade: Definition & Example

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 0:00 Terms Of Trade Defined
  • 1:20 The Formula
  • 2:29 Influences
  • 3:45 Lesson Summary
Add to Add to Add to

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Login or Sign up

Timeline
Autoplay
Autoplay
Speed

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

International trading and trade agreements between countries are important factors that contribute to the globalization of markets. This lesson will discuss terms of trade and their impact on the economies of the countries involved.

Terms of Trade Defined

In economics, terms of trade (TOT) refer to the relationship between how much money a country pays for its imports and how much it brings in from exports. When the price of a country's exports increases over the price of its imports, economists say that the terms of trade has moved in a positive direction. The TOT is expressed as a ratio of import prices to export prices; that is, the amount of imported products/commodities that an economy can purchase, per unit of exported products/commodities. Any improvement that occurs in a country's TOT is beneficial to the economy because it means that the country can purchase more imports for the particular level of exports.

For example, in a bilateral trading arrangement, the trade agreement occurs between two countries. Let's suppose that agricultural products are grown in Bangkok, Thailand, while biological fuels are produced in Malaysia. The price that Malaysia charges for its exports of biological fuels is $24,000,000.00 a year, and it pays Thailand $19,000,000.00 for the produce it imports. At the end of the year, Malaysia would have exported $5,000,000.00 ($24,000,000.00 - $19,000,000.00) more than it has imported.

The Formula

The formula below is used to calculate an economy's TOT:

Terms of Trade (TOT) = Index of Export Prices / Index of Import Prices X 100

The indices are the average of the change in price from one period to the next, expressed as a percentage. Now let's use a real-life example to see how the formula works.

In 2012, the island of Madagascar had an index of export prices of 15% (115) over the previous year and an index of import prices of 7% (107) over the previous year.

Madagascar's TOT = 115 / 107 X 100 = 107.5

The results show an improvement of 7.5% in the TOT. TOTs in excess of 100 are said to be improving, while TOTs below 100 are said to be deteriorating.

NOTE: 15% becomes 115 in the formula because it is 'over' the previous year, the previous year being 100.

Influences

There are a few factors that can influence the terms of trade. The main factors are demand and supply. When a particular product has a high demand globally, it is likely that the country or countries exporting that product would have positive terms of trade. The higher the demand, the more of that product countries are willing to supply to the global market, which has a positive impact on the terms of trade for each producing country.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 160 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create An Account
Support