Cambridge International as and a level Economics Ebook

The terms of trade
A country’s current account position is heavily infl uenced 
by its relative export and import prices. 
Th
e terms of 
trade
is a measure of the ratio of export prices and 
import prices.
Appreciation: 
an increase in the international price of a 
currency caused by market forces.
Revaluation: 
a decision by the government to raise the 
international price of its currency.
KEY TERMS
Figure 4.17 
The J-curve eff ect
Time
0
+
−
Current account position
Figure 4.18 
A rise in the exchange rate limiting the increase in 
aggregate demand
0
Real GDP
AS
AS
P
1
P
2
P
Y
1
Y
2
Y
AD
1
AD
2
AD
1
AD
2
Price level
AD
AD
Figure 4.19 
The reverse J-curve eff ect
Time
0
+
−
Current account position
100

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Chapter 4: The macroeconomy 
Terms of trade index
index of export prices
index of import
=
prices
×
100
Th
e ratio is calculated from the average prices of many 
goods and services that are traded internationally. Th
e 
prices are weighted by the relative importance of each 
product traded.
If the index increases, this is described as a favourable 
movement or an improvement in the terms of trade. 
It means that fewer exports have to be sold to buy any 
given quantity of imports. An unfavourable movement or 
deterioration in the terms of trade means that the index 
number has fallen. Now more exports will have to be 
exchanged to gain the same quantity of imports.