Loading the player...

What are 'Terms of Trade - TOT'?

Terms of trade represent the ratio between a country's export prices and its import prices. The ratio is calculated by dividing the price of the exports by the price of the imports and multiplying the result by 100. When a country’s TOT is less than 100%, more capital is leaving the country than is entering the country. When the TOT is greater than 100%, the country is accumulating more capital from exports than it is spending on imports.

BREAKING DOWN 'Terms of Trade - TOT'

The TOT is used as an indicator of a country’s economic health, but it can lead analysts to draw the wrong conclusions. Changes import and export prices impact the TOT, and it's pertinent to understand what caused the price increases or decreases. TOT measurements are often recorded in an index for economic monitoring purposes.

Factors Affecting Terms of Trade

A variety of factors affect the TOT, and some are unique to specific sectors and industries. Scarcity, or the amount of goods available for trade, is one factor influencing the TOT. The more goods a vendor has available for sale, the more goods it will likely sell, and the more goods that vendor can buy using capital obtained from sales.

For example, during the commodity price boom of the early 2000s, developing countries experienced increases in their terms of trade. When selling a certain quantity of commodities, such as oil and copper, they could buy more consumer goods from other countries.

The size and quality of goods also affect TOT. Larger and higher-quality goods will likely cost more. If goods sell for a higher price, a seller will have additional capital to purchase more goods.

Fluctuating Terms of Trade

When a country’s TOT improves, for every unit of export that a country sells, it can purchase more imported goods. Therefore, an increase in the TOT may be beneficial because the country needs fewer exports to buy a given number of imports. When the TOT increases, it may also have a positive impact on domestic cost-push inflation because the increase is indicative of falling import prices in relation to export prices. However, the country’s export volumes could fall to the detriment of the balance of payments.

When a country’s TOT deteriorates, the country must export a greater number of units to purchase the same number of imports. The Prebisch-Singer hypothesis states that some emerging markets, or developing countries, have experienced declining TOT because of a generalized decline in the price of commodities relative to the price of manufactured goods. In the past two decades, however, a rise in globalization has reduced the price of manufactured goods. Thus, industrialized countries' advantage over developing countries is becoming less significant.

RELATED TERMS
  1. Trade Deficit

    A trade deficit occurs a country's imports exceeds its exports. ...
  2. Net Exports

    Net exports are the value of a country's total exports minus ...
  3. Net Importer

    A net importer is a country or territory whose value of imported ...
  4. Export Incentives

    Export incentives are government programs that encourage a firm, ...
  5. Current Account Deficit

    A current account deficit occurs when the total value of goods ...
  6. Country Risk

    Country risk is a term for a set of risks associated with investing ...
Related Articles
  1. Trading

    Main Factors that Influence Exchange Rates

    The exchange rate is one of the most important determinants of a country's relative level of economic health and can impact your returns.
  2. Insights

    Interesting Facts About Imports and Exports

    Learn how imports and exports exert a profound influence on the consumer and the economy.
  3. Insights

    World's Top 10 Oil Exporters

    Discover the size of the global oil export market, and learn various details about the world's current 10 largest crude oil exporters.
  4. Insights

    The Biggest Losers From China's Slowdown

    A look at how China's slowdown is impacting countries around the world.
  5. Investing

    4 Countries Pleading for Higher Commodity Prices

    Discover what countries are struggling the most from the price collapse in commodities and what these countries require to return to economic growth.
  6. Insights

    What Is International Trade?

    Everyone's talking about globalization, learn what is it and why some oppose it.
  7. Insights

    Could Third World Debt Relief Pay Off?

    Debt is as much a political tool as an economic one. Discover if wholesale debt forgiveness is the answer for developing countries.
  8. Trading

    3 Reasons Why Countries Devalue Their Currency

    Ever since world currencies abandoned the gold standard, many currency devaluation events have sent disruptive ripples across the globe.
  9. Insights

    Top Agricultural Producing Countries

    Discover which countries produce the most agricultural products, which export the most and what is being done to increase production.
RELATED FAQS
  1. What is a trade deficit and what effect will it have on the stock market?

    Learn what is a trade deficit is, also known as net exports, and what effect they have on the stock market. Read Answer >>
  2. What economic indicators are most used when forecasting an exchange rate?

    Discover what economic indicators are most widely used to forecast a country’s exchange rate and how various factors influence ... Read Answer >>
  3. What country is the world's largest exporter of goods?

    Learn about the rapid economic growth China has experienced in recent years and how the country grew into the world's largest ... Read Answer >>
  4. What is a forward contract against an export?

    Understand forward exchange contracts in exporting, and learn the purpose of using a forward contract and its advantages ... Read Answer >>
  5. How do national interest rates affect a currency's value and exchange rate?

    Generally, higher interest rates increase the value of a country's currency and lower interest rates tend to be unattractive ... Read Answer >>
Trading Center