What is 'terms of trade' and why can it affect a country's development prospects?

What is 'terms of trade' and why can it affect a country's development prospects?

• A. The ratio of export quantities to import quantities; fluctuations do not affect development.
• B. The ratio of import prices to export prices; deterioration improves purchasing power.
• C. The ratio of export prices to import prices; deterioration reduces purchasing power for development.
• D. The ratio of government revenue to imports.

Answer: (C)

Terms of trade is the ratio of what a country earns from its exports to what it must spend on its imports. It’s usually written as export prices divided by import prices, often indexed to show changes over time. When this ratio deteriorates, export prices fall relative to import prices, or import prices rise relative to exports. That means the foreign currency earned from exports buys fewer imports, reducing the country’s purchasing power on the international market. This matters for development because many developing economies rely on exporting a narrow range of goods and importing capital goods, technology, and essential goods. A worsening terms of trade shrinks the amount of imports affordable with the same export revenue, hindering investments in infrastructure, education, and productive capacity. It can also strain the current account, lower government revenue from export earnings, and increase exposure to global price swings. Conversely, an improvement in terms of trade increases the amount of imports affordable at the same export level, supporting development efforts.

Terms of trade is the ratio of what a country earns from its exports to what it must spend on its imports. It’s usually written as export prices divided by import prices, often indexed to show changes over time. When this ratio deteriorates, export prices fall relative to import prices, or import prices rise relative to exports. That means the foreign currency earned from exports buys fewer imports, reducing the country’s purchasing power on the international market.

This matters for development because many developing economies rely on exporting a narrow range of goods and importing capital goods, technology, and essential goods. A worsening terms of trade shrinks the amount of imports affordable with the same export revenue, hindering investments in infrastructure, education, and productive capacity. It can also strain the current account, lower government revenue from export earnings, and increase exposure to global price swings. Conversely, an improvement in terms of trade increases the amount of imports affordable at the same export level, supporting development efforts.