Terms of trade (TOT) represent the ratio between a country’s export prices and its import prices. TOT indexes are defined as the value of a country’s total exports minus total imports. The ratio is calculated by dividing the price of the exports by the price of the imports and multiplying the result by 100.
When more capital is leaving the country then is entering into the country then the country’s TOT is less than 100%. When the TOT is greater than 100%, the country is accumulating more capital from exports than it is spending on imports.
The TOT is used as an indicator of a country’s economic health, but it can lead analysts to draw the wrong conclusions. Changes in import prices and export prices impact the TOT, and it’s important to understand what caused the price to increase or to decrease. TOT measurements are often recorded in an index for economic monitoring purposes.1
An improvement or increase in a country’s TOT generally indicates that export prices have gone up as import prices have either maintained or dropped. Conversely, export prices might have dropped but not as significantly as import prices. Export prices might remain steady while import prices have decreased or they might have simply increased at a faster pace than import prices. All these scenarios can result in an improved TOT.
A TOT is dependent to some extent on exchange and inflation rates and prices. A variety of other factors influence the TOT as well, and some are unique to specific sectors and industries.
Scarcity—the number of goods available for trade—is one such factor. 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 ob