Terms of Trade - TOT

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What does 'Terms of Trade - TOT' mean

Terms of trade, or TOT, is a term that represents the prices of the exports of a country, relative to the prices of its imports; the ratio is calculated by dividing the price of the exports by the imports, with the result then being multiplied by 100. When a country’s TOT is less than 100%, more capital is going out than coming in. When the TOT is greater than 100%, the country is accumulating more money from exports than it is spending.

BREAKING DOWN 'Terms of Trade - TOT'

Terms of trade, when used to help determine how healthy a country’s economy is, can lead analysts to draw the wrong conclusions. It is essential for analysts to know why exports increase, in relation to imports, specifically because terms of trade are impacted by the changes that occur in the prices of exports and imports.

Terms of trade measurements are often recorded in an index so that economic monitoring can be performed.

Factors Affecting Terms of Trade

A variety of factors affect terms of trade, with some factors being unique to specific sectors and industries. Scarcity, meaning, the relative amounts of goods available for trade, often has a drastic effect on terms; the greater amount of goods available, the greater amount a vendor is likely to sell or buy using capital obtained from sales.

The size and quality of goods are also factors that have an effect on TOT. The larger a good, the more likely it is to garner a greater sum. Likewise, goods of better or higher quality also garner higher sums. A seller can purchase a greater amount of goods if his goods sell for a greater sum.

Increasing/Decreasing Terms of Trade

When a country’s terms of trade improve, it indicates that for every unit of export that a country sells, it is able to purchase more units of goods that are imported. This means that an increase in the terms of trade may potentially create the implication of benefit, as a higher number of exports would need to have been sold in order to buy the given amount of imports. When terms of trade increase, it may also have a positive effect on domestic cost-push inflation: The increase is indicative of falling import prices in relation to export prices. However, this increase could pose a negative effect in that the country’s export volumes could fall and the balance of payments may worsen.

When a country’s terms of trade worsen, it indicates that the country must export a greater number of units in order to purchase the same given number of imports. The Prebisch-Singer hypothesis states that a number of emerging markets, or developing countries, have experienced this, based on a generalized decline in the price of commodities, relative to the price of goods that are manufactured. In the past two decades, however, a rise in globalization has reduced the price of manufactured goods, thus the advantage that industrialized countries have over developing countries is growing less significant.