Help! Terms of Trade?
If the exchange rate falls, import prices will rise, so ToT worsens.
But does ToT also worsen because export prices fall? Tutor2u & Economicshelp say so, but my college lecturer disagrees.
His argument is that, for example:
Initially, you sell exports at £50.
After your currency depreciates, your export price remains at £50 (but it is now cheaper for foreign countries to buy your exports). ToT is measured in domestic currency (is it?), so export prices remain constant.
I think my lecturer is right, but the online sources are confusing me. I haven't been able to find clarification from any other sources, so please help!
(I'm studying Edexcel A-Level Economic, by the way.)
But does ToT also worsen because export prices fall? Tutor2u & Economicshelp say so, but my college lecturer disagrees.
His argument is that, for example:
Initially, you sell exports at £50.
After your currency depreciates, your export price remains at £50 (but it is now cheaper for foreign countries to buy your exports). ToT is measured in domestic currency (is it?), so export prices remain constant.
I think my lecturer is right, but the online sources are confusing me. I haven't been able to find clarification from any other sources, so please help!
(I'm studying Edexcel A-Level Economic, by the way.)
Original post by allycsf
If the exchange rate falls, import prices will rise, so ToT worsens.
But does ToT also worsen because export prices fall? Tutor2u & Economicshelp say so, but my college lecturer disagrees.
His argument is that, for example:
Initially, you sell exports at £50.
After your currency depreciates, your export price remains at £50 (but it is now cheaper for foreign countries to buy your exports). ToT is measured in domestic currency (is it?), so export prices remain constant.
I think my lecturer is right, but the online sources are confusing me. I haven't been able to find clarification from any other sources, so please help!
(I'm studying Edexcel A-Level Economic, by the way.)
But does ToT also worsen because export prices fall? Tutor2u & Economicshelp say so, but my college lecturer disagrees.
His argument is that, for example:
Initially, you sell exports at £50.
After your currency depreciates, your export price remains at £50 (but it is now cheaper for foreign countries to buy your exports). ToT is measured in domestic currency (is it?), so export prices remain constant.
I think my lecturer is right, but the online sources are confusing me. I haven't been able to find clarification from any other sources, so please help!
(I'm studying Edexcel A-Level Economic, by the way.)
Here's my logic:
A fall in the exchange rate makes exports more price competitive relative to imports. As a result, the terms of trade declines, because it is defined as the ratio of export prices to import prices (i.e. how many imports can I purchase for the sale of exports?). So the decline in the terms of trade results from a) the increased price of imports and b) the decreased price of exports.
Think of it this way; ToT = X/M, by definition, as above. So a depreciation causes X to fall and M to rise. The fraction decreases in value, hence a decline in the terms of trade.
Your method of trying to use a hypothetical example is rather confusing, and I disagree with your lecturer.
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