Which ratio compares export prices to import prices, multiplied by 100?

• A. Balance of Trade
• B. Exchange Rate
• C. Terms of Trade
• D. Trade Balance

Answer: (C)

The main idea here is how a country’s export prices compare to its import prices over time. The terms of trade is the ratio of export prices to import prices, multiplied by 100, usually using price indices: Terms of Trade = (Export Price Index / Import Price Index) × 100. This shows how many units of imports the country can buy with the revenue from its exports, or how much import purchasing power its export earnings have.

For example, if export prices rise while import prices stay the same, the terms of trade increase, meaning exports buy more imports. If import prices rise faster, the terms of trade fall, meaning exports buy fewer imports.

This concept is distinct from the balance of trade (net value of exports minus imports) and from the exchange rate (the value of one currency in terms of another).