A LevelEconomicsCambridge (CIE)Revision NotesInternational Economic IssuesThe Reasons for International TradeThe Terms of Trade

The Terms of Trade (Cambridge (CIE) A Level Economics): Revision Note

Exam code: 9708

Written by: Steve Vorster

Reviewed by: Lisa Eades

Updated on 14 April 2026

What are the terms of trade?

Terms of trade refer to the ratio of a country’s average price of exports to the country’s average price of imports
The relative price of imports and exports can have a direct bearing on the standard of living within a country
- Exporting goods which are highly priced results in higher incomes and the ability to buy cheaper imports
- The terms of trade capture the relationship between the average prices of a country's exports and imports

Calculating the terms of trade

$Terms of trade = \frac{Index of average export prices}{Index of average import prices} \times 100$

The index for exports and imports is created in much the same way that a consumer price index is created (using a weighted basket of imports and exports)

Worked Example

Calculate the terms of trade for Country X. State if the terms of trade have improved or worsened. In the final column explain what that means for country X

Year	Index of average export prices	Index of average import prices
2012	100	100
2013	100	107
2014	112	108
2015	115	110

Worked solution

Year	Index of average export prices	Index of average import prices	Calculation	Terms of trade	Improvement or deterioration?	Explanation
2012	100	100	(100÷100)×100	100	Baseline	Export and import prices are equal
2013	100	107	(100÷107)×100	93.5	Deterioration	Export prices have fallen relative to import prices - Country X must export more to buy the same quantity of imports
2014	112	108	(112÷108)×100	103.7	Improvement	Export prices have risen relative to import prices - Country X can buy more imports for the same quantity of exports
2015	115	110	(115÷110)×100	104.5	Improvement	The terms of trade continue to improve - Country X's exports are becoming relatively more expensive, raising purchasing power over imports

Causes of changes to a country's terms of trade

Relative inflation rates

Inflation increases the price of goods and services within a country
This means that their price is now more expensive to the rest of the world
If the exports are price inelastic in demand, this will improve the terms of trade
If price elastic then it is likely to worsen the terms of trade

Relative productivity rates

Continuous improvements in productivity can lower costs and these can be passed on in the form of lower prices
Lower prices for export products will mean that the terms of trade will deteriorate i.e. fewer imports can be bought with one unit of exports

Changes in exchange rates

Exchange rates constantly change the price of exports and imports
If prices change then the terms of trade between the two countries change
Specific data would need to be provided in order to determine if the terms of trade have improved or deteriorated for each trading partner

Impact of changes in the terms of trade

Depending on the combination of net exports made up in the balance of payments, changes in the terms of trade can have significant macroeconomic effects
Key impacts include effects on: export revenue, import expenditure, the current account of the balance of payments, real incomes and the standard of living

Condition	Cause	ToT movement	PED of exports	Likely outcome
Improvement	Price of exports rises	Above 100 / rising	Elastic (PED >1)	Export revenue falls - buyers switch away from now more expensive exports; current account worsens; employment in export industries may fall
Improvement	Price of exports rises	Above 100 / rising	Inelastic (PED <1)	Export revenue rises - higher prices more than offset lower demand; current account improves; standard of living likely rises
Deterioration	Price of exports falls	Below 100 / falling	Elastic (PED >1)	Export revenue rises - lower prices attract significantly more demand; current account may improve; employment in export industries may rise
Deterioration	Price of exports falls	Below 100 / falling	Inelastic (PED <1)	Export revenue falls - lower prices not offset by sufficient increase in demand; current account worsens; standard of living likely falls

An improvement in the terms of trade generally raises the standard of living if export revenue holds - the country can buy more imports for the same export effort
A deterioration generally reduces purchasing power over imports - the country must export more to maintain the same import volume
The overall effect on the current account of the balance of payments depends critically on the PED of both exports and imports

Examiner Tips and Tricks

Always show your working when calculating the terms of trade - state the formula, substitute the values and round to one decimal place.

A common error is to divide import prices by export prices rather than export prices by import prices, which inverts the result entirely. Remember: exports on top.

When analysing the impact of a terms of trade change, always link to PED before stating the outcome. The direction of the terms of trade change alone does not determine whether export revenue rises or falls - the elasticity of demand is the deciding factor.

An improvement can worsen the current account if export demand is elastic; a deterioration can improve it if demand is elastic.

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