Terms of Trade (TOT)

What are Terms of Trade?

Terms of Trade (TOT) measure the ratio of a country’s export prices to its import prices. It indicates how many imports a country can buy per unit of exports. A TOT greater than 100 (or increasing over time) means a country can obtain more imports for each unit of export—generally viewed as an improvement in trade position.

Key takeaways

• TOT = (Export price index / Import price index) × 100.
• A rising TOT means export prices are favorable relative to import prices; a falling TOT means the opposite.
• Exchange rates, inflation, commodity scarcity, and product quality influence TOT.
• Improved TOT lets a country purchase more imports per export unit; deteriorating TOT can worsen the balance of payments and hurt import capacity.
• Developing countries can face long-term TOT declines if commodity prices lag behind manufactured goods (Prebisch‑Singer hypothesis).

How TOT is calculated

TOT is usually expressed as an index:
TOT = (Export price index / Import price index) × 100

If TOT increases, export prices have risen relative to import prices (or import prices have fallen relative to export prices). If TOT decreases, the reverse is true.

Factors that influence TOT

• Exchange rates — currency appreciation or depreciation alters the relative prices of imports and exports.
• Inflation differentials — higher domestic inflation can raise export prices or make imports cheaper/worse depending on context.
• Commodity prices — large swings in commodity markets can substantially move TOT for commodity-exporting countries.
• Scarcity and supply — availability and quantity of tradable goods affect prices.
• Quality and size of goods — higher-quality or larger-volume goods often fetch higher prices.
• Globalization and technological change — can reduce manufactured-goods prices and shift relative terms between countries.

Economic effects of TOT changes

Positive effects of an improving TOT:
* Greater import purchasing power for a given volume of exports.
* Potential easing of imported cost pressures, which can reduce cost-push inflation.

Potential downsides or complexities:
* Improved TOT can coincide with falling export volumes, harming the balance of payments if export earnings decline.
A deteriorating TOT forces a country to export more to afford the same imports, straining foreign exchange reserves.
Developing economies that rely on primary commodities may experience volatile TOT and long-term declines versus industrialized economies.

Challenges for developing countries

Developing countries often depend on commodity exports. When commodity prices fall relative to manufactured goods, their TOT decline, reducing the real value of exports and limiting import capacity. Temporary commodity booms can improve TOT, but globalization and declining manufactured-goods prices may erode those gains over time. This dynamic underlies concerns described by the Prebisch‑Singer hypothesis.

How countries can improve TOT

• Strengthen export competitiveness through productivity gains and value addition to exports.
• Manage exchange-rate policy to avoid undue loss of import purchasing power.
• Diversify export base away from a narrow set of volatile commodities.
• Pursue trade and industrial policies that boost higher-value or higher-quality exports.

Conclusion

Terms of Trade is a concise indicator of a country’s relative trade price position and purchasing power for imports. Monitoring TOT helps policymakers and analysts assess how price movements, exchange rates, and structural factors affect a country’s ability to buy foreign goods with its exports. Improvements in TOT can bolster economic welfare, while deteriorations—especially for commodity-dependent developing countries—can create persistent challenges.