MCQs on Terms of Trade and Explanation | International Economics Notes

Terms of Trade (TOT) – Meaning, Types, and Determination in International Economics

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Meaning of Terms of Trade

Terms of Trade (TOT) refer to the ratio between the prices of a country’s exports and the prices of its imports. It measures how much import goods a country can obtain per unit of export goods. Essentially, it indicates the purchasing power of a country's exports in terms of imports. 

• Formula:

$$$$Terms of Trade=Index of Export PricesIndex of Import Prices×100

• If TOT > 100%, it means export prices have risen relative to import prices, allowing the country to buy more imports for the same amount of exports (improvement in TOT).
• If TOT < 100%, it means import prices have risen relative to export prices, reducing the country’s purchasing power (deterioration in TOT)1346.

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Importance of Terms of Trade

• Indicator of Economic Health: TOT reflects a country's competitiveness and economic well-being.
• Purchasing Power: Higher TOT means a country can import more for a given quantity of exports, improving living standards.
• Trade Policy: Helps policymakers understand trade dynamics and negotiate better trade agreements.

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Types of Terms of Trade

According to economists like Jacob Viner and Meier, there are several types of Terms of Trade, each emphasizing different aspects of trade:

Type	Definition & Formula	Explanation
1. Net Barter (Commodity) Terms of Trade	$T_n = \frac{P_x}{P_m}$ where $P_x$ = Export price index, $P_m$= Import price index	Ratio of export prices to import prices; most commonly used measure27.
2. Gross Barter Terms of Trade	$T_g = \frac{Q_m}{Q_x}$ where $Q_m$ = Quantity of imports, $Q_x$ = Quantity of exports	Ratio of physical quantities of imports to exports; shows volume trade relationship27.
3. Income Terms of Trade	$T_y = \frac{P_x}{P_m} \times Q_x$	Combines price and export volume; measures purchasing power of export earnings27.
4. Single Factor Terms of Trade	$T_s = \frac{P_x}{P_m} \times Z_x$ where $Z_x$ = Productivity index of export sector	Adjusts net barter terms for productivity changes in export sector27.
5. Double Factorial Terms of Trade	$T_d = T_c \times \frac{Z_x}{Z_m}$  where $Z_x$, $Z_m$ = Productivity indexes of domestic export and foreign import sectors	Accounts for productivity differences in both export and import sectors27.
6. Real Cost Terms of Trade	$T_r = T_s \times R_x$ where $R_x$ = Disutility or real cost of producing exports	Reflects the real cost (effort, sacrifice) involved in export production27.
7. Utility Terms of Trade	$T_u = T_r \times U$ where $U$ = Utility index comparing imports and domestic goods	Incorporates consumer utility or satisfaction from imports relative to domestic goods forgone27.

Determination of Terms of Trade

The terms of trade are determined by the interaction of export and import prices and the relative demand and supply of goods in international markets.

Price Indexes:

• Export Price Index (PX): Measures average prices of a basket of export goods.
• Import Price Index (PM): Measures average prices of a basket of import goods.
• The ratio of these indexes determines the TOT134.

Reciprocal Demand:

• The mutual demand between countries for each other’s goods influences the equilibrium terms of trade.
• If a country’s demand for imports is strong relative to the other country’s demand for its exports, terms of trade shift in favor of the exporting country6.

Supply and Demand Factors:

• Changes in global supply or demand for certain commodities (e.g., oil price shocks) affect export or import prices, thus affecting TOT.
• Exchange rates also impact TOT by influencing import prices in domestic currency terms46.

Trade Volume and Productivity:

• Increases in export volume or productivity can improve income terms of trade, allowing a country to afford more imports27.

Illustrative Example

Suppose Country A exports rice and imports wheat:

• Export price index (rice) = 120 (base year 100)
• Import price index (wheat) = 100 (base year 100)

Terms of Trade = (120 / 100) × 100 = 120

This means Country A can buy 20% more wheat for the same amount of rice exports compared to the base year, indicating an improvement in TOT7.

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Summary

Aspect	Details
Meaning	Ratio of export prices to import prices; indicates purchasing power of exports
Formula	$\text{TOT} = \frac{P_x}{P_m} \times 100$
Types	Net barter, gross barter, income, single factor, double factorial, real cost, utility terms of trade
Determination	Based on export/import price indexes, reciprocal demand, supply-demand changes, productivity
Economic Significance	Reflects competitiveness, affects living standards, guides trade policy

References

• OECD defines TOT as the ratio between export and import price indexes1.
• Various types of TOT elaborated by Jacob Viner and others27.
• Calculation and economic implications explained in detail by Investopedia and Study.com345.
• Reciprocal demand and price interaction influence TOT determination6.

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This detailed explanation covers the meaning, types, and determinants of Terms of Trade, providing a comprehensive understanding of this key international economics concept.

Top 20 MCQs on Terms of Trade (with Answers)

1. What do Terms of Trade (TOT) measure?
   a) Ratio of export prices to import prices
   b) Ratio of import quantities to export quantities
   c) Exchange rate between two currencies
   d) Tariff rates between countries
   Answer: a) Ratio of export prices to import prices

2. If the Terms of Trade index is above 100, it means:
   a) Export prices have fallen relative to import prices
   b) Import prices have risen relative to export prices
   c) Export prices have risen relative to import prices
   d) No change in trade conditions
   Answer: c) Export prices have risen relative to import prices

3. Which of the following is the formula for Net Barter Terms of Trade?
   a) Export price index / Import price index × 100
   b) Import price index / Export price index × 100
   c) Quantity of exports / Quantity of imports × 100
   d) Export volume × Import volume
   Answer: a) Export price index / Import price index × 100

4. Gross Barter Terms of Trade is concerned with:
   a) Price ratios
   b) Quantity ratios of imports and exports
   c) Income from trade
   d) Productivity adjustments
   Answer: b) Quantity ratios of imports and exports

5. Income Terms of Trade combine:
   a) Export prices and import prices
   b) Export prices and export volume
   c) Import prices and import volume
   d) Export volume and import volume
   Answer: b) Export prices and export volume

6. Which type of Terms of Trade accounts for productivity changes in export sector?
   a) Net Barter Terms of Trade
   b) Single Factor Terms of Trade
   c) Gross Barter Terms of Trade
   d) Income Terms of Trade
   Answer: b) Single Factor Terms of Trade

7. Double Factorial Terms of Trade consider productivity changes in:
   a) Only export sector
   b) Only import sector
   c) Both export and import sectors
   d) Neither sector
   Answer: c) Both export and import sectors

8. Real Cost Terms of Trade include:
   a) Export prices only
   b) Import prices only
   c) Real cost or disutility of producing exports
   d) Exchange rates
   Answer: c) Real cost or disutility of producing exports

9. Utility Terms of Trade measure:
   a) Price ratios only
   b) Consumer satisfaction from imports relative to domestic goods
   c) Export volume changes
   d) Tariff effects
   Answer: b) Consumer satisfaction from imports relative to domestic goods

10. Which factor primarily determines the Terms of Trade between two countries?
    a) Reciprocal demand
    b) Absolute advantage
    c) Population size
    d) Currency strength
    Answer: a) Reciprocal demand

11. An improvement in Terms of Trade means:
    a) A country can import less for the same exports
    b) Export prices have decreased relative to import prices
    c) A country can import more for the same exports
    d) Import prices have decreased relative to export prices
    Answer: c) A country can import more for the same exports

12. If export prices fall and import prices rise, the Terms of Trade will:
    a) Improve
    b) Deteriorate
    c) Remain unchanged
    d) Become unpredictable
    Answer: b) Deteriorate

13. Offer curves are used to:
    a) Determine tariff rates
    b) Show quantities a country is willing to export and import at different terms of trade
    c) Measure absolute advantage
    d) Calculate GDP
    Answer: b) Show quantities a country is willing to export and import at different terms of trade

14. The intersection of two countries’ offer curves determines:
    a) Exchange rates
    b) Equilibrium Terms of Trade
    c) Tariff levels
    d) Production possibilities
    Answer: b) Equilibrium Terms of Trade

15. Which of the following is NOT a type of Terms of Trade?
    a) Net Barter Terms of Trade
    b) Gross Barter Terms of Trade
    c) Elasticity Terms of Trade
    d) Income Terms of Trade
    Answer: c) Elasticity Terms of Trade

16. Terms of Trade deteriorate when:
    a) Export prices rise faster than import prices
    b) Import prices rise faster than export prices
    c) Export and import prices rise equally
    d) Export prices fall while import prices remain constant
    Answer: b) Import prices rise faster than export prices

17. Which type of Terms of Trade reflects the purchasing power of a country's exports?
    a) Net Barter Terms of Trade
    b) Income Terms of Trade
    c) Gross Barter Terms of Trade
    d) Single Factor Terms of Trade
    Answer: b) Income Terms of Trade

18. Terms of Trade are important for:
    a) Determining a country's economic welfare
    b) Setting domestic tax rates
    c) Calculating inflation only
    d) Measuring population growth
    Answer: a) Determining a country's economic welfare

19. A country’s Terms of Trade improve when:
    a) It can buy more imports for a given quantity of exports
    b) It exports more quantities regardless of prices
    c) It imports more goods than exports
    d) Its currency depreciates sharply
    Answer: a) It can buy more imports for a given quantity of exports

20. Which of the following affects Terms of Trade?
    a) Changes in global demand and supply
    b) Exchange rate fluctuations
    c) Trade policies and tariffs
    d) All of the above
    Answer: d) All of the above

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These MCQs comprehensively cover the meaning, types, and determination of Terms of Trade in international economics.

References:

1. https://www.oecd.org/en/data/indicators/terms-of-trade.html
2. https://dspmuranchi.ac.in/pdf/Blog/INTERNATIONAL%20BUSINESS%20AND%20TRADE%20UNIT-3%20PART-I.pdf
3. https://testbook.com/ugc-net-economics/terms-of-trade
4. https://www.investopedia.com/terms/t/terms-of-trade.asp
5. https://study.com/academy/lesson/terms-of-trade-in-economics-definition-formula-examples.html
6. https://en.wikipedia.org/wiki/Terms_of_trade
7. https://jncollegeonline.co.in/attendence/classnotes/files/1627267046.pdf
8. https://pmt.physicsandmathstutor.com/download/Economics/A-level/Notes/Edexcel-IAL/Unit-4/2-Trade-and-the-World-Economy/c)%20Terms%20of%20trade.pdf
9. https://www.wallstreetmojo.com/terms-of-trade/
10. https://www.studocu.com/in/document/alagappa-university/international-economics/the-factors-determining-terms-of-trade/52998932
11. https://testbook.com/objective-questions/mcq-on-international-trade--626f79bc99ef5dca9190e1e8
12. https://byjus.com/commerce/mcq-on-international-trade-and-finance/
13. https://study.com/academy/practice/quiz-worksheet-terms-of-trade.html
14. https://www.scribd.com/document/589400077/International-Trade-MCQ-With-Answers-PDF-1
15. https://www.scribd.com/document/499025747/International-Trade-multiple-choice-questions
16. https://testbook.com/objective-questions/mcq-on-theories-of-international-trade--5fc42832a1bc541cc2ffc9c8
17. http://www.shvocc.edu.in/images/PDFs/Sem-VI-Business%20Economics-VI%20MCQ.pdf
18. https://www.studocu.com/row/document/bahauddin-zakariya-university/public-international-law/international-trade-mcq-with-answers/30157999
19. https://deufob.files.wordpress.com/2016/08/international-economics-multiple-choice-questions.pdf