What are Terms of Trade in the context of the global economy?

Terms of Trade (ToT) refer to the ratio at which a country's exports are exchanged for imports. It is calculated by dividing the price index of exports by the price index of imports and multiplying by 100. A higher ToT indicates that a country can purchase more imports for a given quantity of exports, which is beneficial for its economy. This concept is crucial in understanding international trade dynamics, especially in the Edexcel International A Levels Economics curriculum.

How do changes in Terms of Trade affect a country's economy?

Changes in Terms of Trade can significantly impact a country's economy. An improvement in ToT means that a country can buy more imports with the same amount of exports, potentially leading to increased national income and economic growth. Conversely, a deterioration in ToT means the opposite, which can lead to reduced purchasing power and economic challenges. This is an important aspect of the 'Developments in the Global Economy' topic in Edexcel International A Levels Economics.

What factors can influence a country's Terms of Trade?

Several factors can influence a country's Terms of Trade, including changes in global demand and supply, exchange rates, inflation rates, and trade policies. For instance, if a country's main export becomes more in demand globally, its ToT may improve. Understanding these factors is essential for students studying Economics, particularly in the context of the Edexcel International A Levels curriculum.

Why is it important for students to study Terms of Trade in Economics?

Studying Terms of Trade is important because it provides insights into a country's economic health and its position in the global market. It helps students understand how international trade affects national economies and the global economy as a whole. This knowledge is crucial for analyzing economic policies and making informed decisions, aligning with the objectives of the Edexcel International A Levels Economics syllabus.

How do Terms of Trade relate to economic development?

Terms of Trade are closely related to economic development as they affect a country's ability to import goods and services, which can influence its economic growth. Favorable ToT can lead to increased investment in infrastructure and human capital, driving development. Conversely, unfavorable ToT can hinder economic progress. This relationship is a key focus in the 'Developments in the Global Economy' section of the Edexcel International A Levels Economics course.

Why is "Confusing the terms of trade with the balance of trade" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: Both concern exports and imports, so the terms are easily blurred. How to avoid it: TERMS OF TRADE = a ratio of export PRICES to import PRICES (an index number, 100 = base year). BALANCE OF TRADE = the VALUE of exports minus the value of imports (a £ surplus or deficit). One is a price ratio; the other is a money value. Source: WEC14 Examiner Reports — recurring error

Why is "Assuming an improvement in the terms of trade is always good" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: The word 'improvement' sounds unambiguously positive. How to avoid it: An improvement means DEARER exports and CHEAPER imports. If demand for exports is price-ELASTIC, export revenue falls and the current account can WORSEN. The word describes the price ratio, not the trade or welfare outcome — always bring in elasticity. Source: WEC14 Examiner Reports

Why is "Treating the terms of trade as a ratio of volumes or values" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: Students think the terms of trade measure how much is traded or the trade balance. How to avoid it: The terms of trade compare the average PRICE INDICES of exports and imports — not quantities and not values. Volumes and values determine the balance of trade, not the terms of trade. Source: WEC14 mark schemes

Why is "Dividing import prices by export prices (the formula upside down)" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: Students forget which index is the numerator. How to avoid it: Terms of trade = EXPORT price index ÷ IMPORT price index × 100. Export prices go on TOP. A quick check: if export prices rise relative to import prices the answer should rise ABOVE 100 (an improvement). Source: WEC14 mark schemes

Why is "Thinking a stronger currency causes a deterioration in the terms of trade" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: Students link a strong currency to weaker exports and assume the terms of trade must fall too. How to avoid it: An APPRECIATION makes exports dearer and imports cheaper, so export prices rise relative to import prices → the terms of trade IMPROVE. (Competitiveness may fall, but the price ratio rises — separate the two effects.) Source: WEC14 Examiner Reports

Why is "Ignoring primary product dependency and Prebisch–Singer in evaluation" a common mistake in Terms of Trade (Trade and the Global Economy)?

Why it happens: Students describe a terms-of-trade change without linking it to development. How to avoid it: For commodity exporters, bring in the PREBISCH–SINGER hypothesis (long-run deterioration for primary-product exporters) and PRIMARY PRODUCT DEPENDENCY (volatile earnings, case for diversification) — but treat Prebisch–Singer as a contested long-run tendency, not an iron law. Source: WEC14 Examiner Reports

Edexcel International A Levels Economics (XEC11-YEC11)

Terms of Trade (Trade and the Global Economy)

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Short Notes - Terms of Trade (Trade and the Global Economy)

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Detailed Study Notes

Detailed notes on Developments in the Global Economy for Edexcel International A Levels Economics, covering key concepts, explanations, examples, and exam-focused revision points.

Terms of Trade — The International Economy — Edexcel IAL Economics (WEC14) Study Notes

The terms of trade measure the rate at which a country's exports exchange for its imports. Learn the exact formula (index of export prices ÷ index of import prices × 100), how to calculate it and read an improvement from a deterioration, the four causes examiners set (relative inflation, exchange rates, world demand/supply and productivity), and why an improvement is not always 'good' — linking to the Prebisch–Singer hypothesis and primary product dependency for a top-band Unit 4 evaluation.

At a glance

Terms of trade = the rate at which a country's exports exchange for its imports — how many imports a unit of exports buys.
Formula: terms of trade = (index of average export prices ÷ index of average import prices) × 100.
It is a ratio of PRICE INDICES, not of volumes or of export value against import value — do not confuse it with the balance of trade.
A rise (improvement) means export prices rise relative to import prices — a unit of exports now buys more imports.
A fall (deterioration) means export prices fall relative to import prices — a unit of exports buys fewer imports.
Causes: relative inflation rates, exchange-rate movements, changes in world demand/supply (commodity price swings) and productivity.
An improvement is not always good: whether the current account improves depends on the price elasticities of demand for exports and imports.
Prebisch–Singer hypothesis: a long-run decline in the terms of trade of primary-product exporters — a key problem of primary product dependency.

What you’ll learn

Mapped to the Pearson Edexcel International A Levels XEC11-YEC11 syllabus (2020-2026).

4.1.5 — Understand the terms of trade as the rate at which a country's exports exchange for imports.
4.1.5 — Calculate the terms of trade from indices of average export and import prices.
4.1.5 — Distinguish an improvement (rise) from a deterioration (fall) in the terms of trade and interpret each.
4.1.5 — Explain the causes of changes in the terms of trade: relative inflation, exchange rates, world demand/supply and productivity.
4.1.5 — Analyse and evaluate the effects of changes in the terms of trade, including the link to elasticity, the Prebisch–Singer hypothesis and primary product dependency.

What the terms of trade measure — and the formula

The terms of trade compare a country's average export prices with its average import prices; the ratio of the two price indices (× 100) tells you how many imports a unit of exports can buy.

The terms of trade measure the rate at which a country's exports exchange for its imports — in plain terms, how many units of imports a given quantity of exports will buy. They are calculated from price indices, so they compare the average price of what a country sells with the average price of what it buys:

$\text{Terms of trade} = \frac{\text{index of average export prices}}{\text{index of average import prices}} \times 100$

Each index is set to 100 in a base year, so the terms of trade themselves also equal 100 in the base year. A figure above 100 means export prices have risen faster (or fallen more slowly) than import prices since the base year; a figure below 100 means the opposite.

A concrete way to picture it. Suppose a country exports coffee and imports machinery. If the world price of its coffee rises while machinery prices stay put, each sack of coffee now earns enough to buy more machinery than before — the country's exports 'go further', and the terms of trade rise. If instead coffee prices fall while machinery prices climb, each sack buys less machinery, and the terms of trade fall.

It is a ratio of PRICES, not volumes or values. This is the single most important thing to hold on to. The terms of trade say nothing directly about how much a country exports or imports, nor about whether trade is in surplus or deficit — they compare only the average prices of exports and imports. That is what separates them from the balance of trade (covered below).

Terms of trade = the rate at which exports exchange for imports.
Formula: (index of export prices ÷ index of import prices) × 100.
= 100 in the base year; above 100 = export prices rose relative to import prices.
It compares PRICES only — not volumes, values or the trade balance.

See the full worked example for terms of trade (trade and the global economy) →

Improvement vs deterioration — reading the direction

A rise in the terms of trade is an 'improvement' (exports buy more imports); a fall is a 'deterioration' (exports buy fewer imports). The words describe the price ratio, not necessarily national welfare.

Because the terms of trade are a ratio, only the relative movement of export and import prices matters — not whether prices are rising or falling overall.

An improvement (a rise) in the terms of trade occurs when export prices rise relative to import prices. A unit of exports now buys more imports. This happens if export prices rise while import prices are steady, if export prices rise faster than import prices, or even if both fall but import prices fall further.
A deterioration (a fall) occurs when export prices fall relative to import prices. A unit of exports buys fewer imports. This happens if export prices fall while import prices hold, if import prices rise while export prices hold, or if export prices rise more slowly than import prices.

Movement	What happens to the ratio	Meaning
Improvement	Terms of trade rise (e.g. 100 → 108)	Export prices up relative to import prices → exports buy more imports
Deterioration	Terms of trade fall (e.g. 100 → 94)	Export prices down relative to import prices → exports buy fewer imports

Beware the loaded words. 'Improvement' and 'deterioration' describe only the price ratio — they are not value judgements about the whole economy. As the effects section shows, an improvement can actually worsen the current account, and a deterioration can boost export competitiveness. Examiners reward candidates who use the words correctly for the ratio and recognise that the economic consequences can point the other way.

Improvement = terms of trade RISE = export prices up relative to import prices.
Deterioration = terms of trade FALL = export prices down relative to import prices.
Only the RELATIVE movement of the two price indices matters.
'Improvement/deterioration' describe the ratio, NOT overall welfare.

See the full worked example for terms of trade (trade and the global economy) →

Causes of a change in the terms of trade

The terms of trade move with relative inflation rates, exchange-rate changes, shifts in world demand and supply (commodity prices), and relative productivity.

Anything that changes export prices relative to import prices changes the terms of trade. Four causes recur in Unit 4.

1. Relative inflation rates. If a country's inflation is higher than its trading partners', its export prices rise faster than the import prices it faces. Faster-rising export prices raise the terms of trade in the short run (an improvement on paper), even though the country is becoming less competitive. Lower relative inflation does the reverse.

2. Exchange-rate movements. A stronger currency (appreciation) makes exports dearer in foreign currency and imports cheaper in domestic currency — export prices rise relative to import prices, so the terms of trade improve. A weaker currency (depreciation) does the opposite, causing a deterioration. (Note the twist: an appreciation improves the terms of trade but usually worsens trade competitiveness.)

3. Changes in world demand and supply — commodity price swings. Shifts in the world market for a country's exports or imports move their prices directly:

A rise in world demand for a country's exports (or a supply shortage) raises export prices → improvement. A commodity boom, for example, lifts the terms of trade of oil or metal exporters.
A rise in world supply of those exports (a glut) lowers export prices → deterioration.
Higher world prices for imports (e.g. an energy-price spike for an oil importer) raise import prices → deterioration. This is why commodity-dependent economies see volatile terms of trade that swing sharply with world prices.

4. Relative productivity. If a country's productivity rises faster than its rivals', it can produce exports more cheaply and may cut export prices to win market share — lowering the terms of trade (a deterioration on paper) while gaining competitiveness. Slower relative productivity growth tends to raise export prices and the terms of trade.

Relative inflation: higher domestic inflation raises export prices → improvement (but less competitive).
Exchange rate: appreciation → dearer exports, cheaper imports → improvement; depreciation → deterioration.
World demand/supply: a commodity boom raises export prices → improvement; a glut or dearer imports → deterioration.
Productivity: faster productivity growth can cut export prices → deterioration but more competitive.

Effects of a change — and why elasticity decides

An improvement can raise living standards (imports are relatively cheaper) but may worsen the current account if demand for exports is elastic — so the effect on trade depends on price elasticities.

A change in the terms of trade has two competing effects, and which dominates depends on price elasticities of demand for exports and imports.

Effects of an IMPROVEMENT (a rise).

Living standards: each unit of exports now buys more imports, so imports are relatively cheaper. A country can enjoy more imported goods for the same exports, which — other things equal — can raise real living standards and ease imported cost-push inflation.
The current account — it depends on elasticity. An improvement usually means dearer exports and cheaper imports. If demand for exports and imports is price-elastic, the higher export price causes a more-than-proportionate fall in export volume (export revenue falls) while cheaper imports are bought in much larger quantity (import spending rises) — so the current account worsens. If demand is price-inelastic, revenue effects are small and the current account may be little affected or even improve. This is the same logic as the Marshall–Lerner condition: a price change worsens the trade balance when demand is elastic enough.

Effects of a DETERIORATION (a fall).

A deterioration means cheaper exports and dearer imports. If demand is elastic, cheaper exports sell in much larger volume (revenue rises) and dearer imports are bought less — so the current account can improve even though the country is, in ratio terms, 'worse off'. If demand is inelastic (common for commodity exporters and for essential imports like fuel), a deterioration can cut export revenue and raise the import bill, worsening the current account and squeezing living standards.

The headline lesson. An 'improvement' in the terms of trade is not automatically good and a 'deterioration' is not automatically bad. The impact on the current account hinges on the price elasticities of demand for exports and imports; the impact on living standards depends on how far cheaper imports offset any lost export revenue.

Improvement → imports relatively cheaper → can raise living standards.
But an improvement means dearer exports/cheaper imports → current account worsens IF demand is elastic.
Deterioration → cheaper exports → current account can improve IF demand is elastic.
Effect on the current account depends on price elasticities (Marshall–Lerner logic).

Prebisch–Singer, primary product dependency and the balance of trade

The Prebisch–Singer hypothesis argues that primary-product exporters face a long-run decline in their terms of trade; this is a core problem of primary product dependency. Keep the terms of trade distinct from the balance of trade.

The Prebisch–Singer hypothesis. Economists Raúl Prebisch and Hans Singer argued that, over the long run, the terms of trade of countries that mainly export primary products (commodities such as coffee, cocoa, copper and oil) tend to decline relative to countries exporting manufactures. The reasoning:

Demand for primary products is income-inelastic — as world incomes rise, spending on raw materials and food grows only slowly (Engel's law), whereas demand for manufactures and services rises strongly. So export prices of commodities lag behind.
Manufactured goods can be differentiated and branded, and producers (or unions) have more power to hold prices up; commodity markets are competitive and prices are easily driven down by new supply.
Technological progress and synthetic substitutes can reduce demand for some raw materials.

If commodity export prices drift down while the prices of imported manufactures hold or rise, a primary-product exporter's terms of trade fall over time — meaning it must export ever more raw material to buy the same imports.

Primary product dependency. This is the danger for many developing economies that rely on a narrow range of commodity exports:

Volatile export prices (commodity prices swing sharply) make export earnings and government revenue unstable.
A long-run deterioration in the terms of trade (Prebisch–Singer) can trap them exporting more for less, hampering development.
It encourages the case for diversification into manufacturing and services, and for adding value to raw materials rather than exporting them unprocessed.

Terms of trade vs balance of trade — keep them separate. These are frequently confused, but they measure different things:

	Terms of trade	Balance of trade
Measures	The ratio of export prices to import prices (a price index)	The value of exports minus the value of imports
Units	An index number (100 = base year)	A money value (£ surplus or deficit)
Tells you	How many imports a unit of exports buys	Whether trade is in surplus or deficit

A country can have a terms-of-trade improvement and still run a trade deficit, or a deterioration while running a surplus — because volumes and elasticities, not just prices, determine the balance of trade.

Prebisch–Singer: primary-product exporters face a long-run FALL in their terms of trade.
Cause: commodity demand is income-inelastic; manufactures hold prices better; substitutes reduce demand.
Primary product dependency → volatile earnings + long-run deterioration → case for diversification.
Terms of trade = price RATIO (index); balance of trade = export VALUE minus import VALUE (£).

Quick recap

Terms of trade = the rate at which exports exchange for imports = (index of export prices ÷ index of import prices) × 100.
= 100 in the base year; it is a ratio of PRICE INDICES, not volumes, values or the trade balance.
Improvement (rise) = export prices up relative to import prices (exports buy more imports); deterioration (fall) = the reverse.
Causes: relative inflation, exchange-rate movements, world demand/supply (commodity prices) and relative productivity.
An improvement raises living standards (cheaper imports) but can WORSEN the current account if export/import demand is elastic.
Prebisch–Singer: primary-product exporters face a long-run deterioration — a core problem of primary product dependency.
Keep the terms of trade (price ratio) distinct from the balance of trade (value of exports minus imports).

Memorise this

Verbatim phrases and definitions Edexcel mark schemes credit.

Terms of trade = the rate at which a country's exports exchange for its imports.
Terms of trade = (index of average export prices ÷ index of average import prices) × 100 (= 100 in the base year).
Improvement (rise) = export prices rise RELATIVE to import prices → a unit of exports buys MORE imports.
Deterioration (fall) = export prices fall relative to import prices → a unit of exports buys FEWER imports.
Causes: relative inflation rates, exchange-rate movements, changes in world demand/supply (commodity prices), relative productivity.
Prebisch–Singer hypothesis = a long-run decline in the terms of trade of primary-product exporters (primary product dependency).

How it’s examined

Terms of trade is a Unit 4 (WEC14) 'international economy' topic and is calculation-central. In Section B, Q7(a) expect a short 2-mark calculate — compute the terms of trade from an index of export prices and an index of import prices — where you must show the formula, substitution and the figure, then state whether it is an improvement or deterioration. The (c) 4-mark explain may ask what an improvement means; the (b) 6-mark analyse part often traces how a commodity-price change or exchange-rate movement affects a country's terms of trade; the (d) 8-mark examine part sets two causes of a change; and the (e) 14-mark discuss (KAA 8 + Eval 6) weighs the consequences — bringing in elasticity and the current account. In Section C, terms of trade underpins 20-mark Evaluate essays (KAA 12 + Eval 8) such as whether a deterioration is always bad, where the Prebisch–Singer hypothesis, primary product dependency and the elasticity/Marshall–Lerner logic are the discriminators. Examiner reports flag recurring errors: confusing the terms of trade with the balance of trade, treating an improvement as automatically 'good', dividing the wrong way round, and mixing up volumes with prices.

Sources: Pearson Edexcel International Advanced Level Economics (XEC11/YEC11) Specification, Issue 2; Edexcel IAL Economics WEC14 Examiner Reports; Edexcel IAL Economics WEC14 mark schemes. Last reviewed 2026-07-01.

Take this whole topic with you

Step-by-step worked examples — Terms of Trade (Trade and the Global Economy)

Step-by-step solutions to past-paper-style questions on terms of trade (trade and the global economy), written exactly the way a tutor would explain them at the board.

Question type:

1Calculate the terms of trade from price indices
Getting startedDirect calculation• WEC14/01 Section B, Q7(a) style• terms of trade, price index, calculation, AO2
Question
A country's index of average export prices is 120 and its index of average import prices is 100 (base year = 100). Calculate the terms of trade and state whether they have improved or deteriorated. (2 marks)
Step-by-step solution
1. Step 1
  Identify the formula — the terms of trade are the ratio of the two price indices × 100.
  $\text{Terms of trade} = \frac{\text{index of export prices}}{\text{index of import prices}} \times 100$
2. Step 2
  Substitute the figures.
  $= \frac{120}{100} \times 100$
3. Step 3
  Calculate.
  $= 120$
4. Step 4
  Interpret. The terms of trade are 120, above the base-year 100, so export prices have risen relative to import prices — an improvement: a unit of exports now buys more imports.
Answer
Terms of trade = 120 — an improvement (above 100).
Examiner tip
2/2: 1 mark for the correct value (120), 1 for stating it is an improvement / above the base year. Show the formula and substitution — method marks apply. Dividing import prices by export prices (getting 83.3) is the classic slip.
2Classify: improvement or deterioration?
Getting startedIdentify & classify• terms of trade, improvement, deterioration, AO1
Question
State whether each change describes an improvement or a deterioration in the terms of trade: (i) export prices rise 6%, import prices unchanged; (ii) export prices unchanged, import prices rise 5%; (iii) both fall, but import prices fall by more than export prices.
Step-by-step solution
1. Step 1
  (i) Export prices rise relative to import prices → the ratio rises → improvement (exports buy more imports).
2. Step 2
  (ii) Import prices rise while export prices hold → export prices fall relative to import prices → the ratio falls → deterioration.
3. Step 3
  (iii) Both fall, but import prices fall further, so export prices are higher relative to import prices → the ratio rises → improvement.
Answer
(i) improvement; (ii) deterioration; (iii) improvement.
Examiner tip
The examined skill is spotting that only the RELATIVE movement matters. In (iii), both prices fall yet the terms of trade still improve because import prices fall by more — a favourite trap. Judge the ratio, not the direction of either price alone.
3Calculate the terms of trade when both indices change
Building confidenceMulti-step problem• WEC14/01 Section B, Q7(a) style• terms of trade, price index, calculation, AO2
Question
In Year 1 the index of export prices is 100 and the index of import prices is 100. In Year 2 export prices rise to 110 and import prices rise to 125. Calculate the terms of trade in each year and state what has happened. (4 marks)
Step-by-step solution
1. Step 1
  Year 1 terms of trade.
  $= \frac{100}{100} \times 100 = 100$
2. Step 2
  Year 2 terms of trade — apply the formula with the new indices.
  $= \frac{110}{125} \times 100$
3. Step 3
  Compute Year 2.
  $= 0.88 \times 100 = 88$
4. Step 4
  Interpret. The terms of trade fall from 100 to 88. Even though export prices rose (+10%), import prices rose faster (+25%), so export prices fell relative to import prices — a deterioration: a unit of exports now buys fewer imports.
Answer
Year 1 = 100; Year 2 = 88 → a deterioration (import prices rose faster than export prices).
Examiner tip
AO2: full marks need both index values and the interpretation. The teaching point is that RISING export prices can still mean a DETERIORATION if import prices rise faster — the ratio, not the absolute export price, decides. Rounding 0.88 is fine provided working is shown.
4Analyse how a commodity-price fall affects the terms of trade
Building confidenceWord problem• WEC14/01 Section B, Q7(b) style• commodity prices, primary product dependency, terms of trade, AO3
Question
A developing economy relies on copper for 70% of its exports and imports mostly manufactured goods. World copper prices fall sharply. Analyse the likely effect on the country's terms of trade. (6 marks)
Step-by-step solution
1. Step 1
  Identify the dependency. With copper at 70% of exports, the index of average export prices is dominated by the world copper price.
2. Step 2
  Apply the shock. A sharp fall in the world copper price pulls the index of export prices down, while import prices (manufactures) are little changed.
3. Step 3
  Use the formula. Since terms of trade = export-price index ÷ import-price index × 100, a lower numerator against a steady denominator makes the ratio fall.
  $\text{Terms of trade} = \frac{\downarrow \text{export prices}}{\text{import prices}} \times 100 \Rightarrow \text{ratio falls}$
4. Step 4
  Conclude. The terms of trade deteriorate: each unit of copper now buys fewer imported manufactures, so the country must export more copper to buy the same imports — the classic vulnerability of primary product dependency.
Answer
Export prices fall relative to steady import prices, so the terms of trade deteriorate — a unit of exports buys fewer imports, illustrating primary product dependency.
Examiner tip
AO3 chain rewarded: dominant export → export-price index falls → ratio falls → deterioration, linked to primary product dependency. Naming the mechanism (numerator falls, denominator steady) and the dependency point reaches the top of the level.
5Explain how an appreciation affects the terms of trade
StretchWord problem• WEC14/01 Section B, Q7(b)/(c) style• exchange rate, appreciation, competitiveness, AO3
Question
The domestic currency appreciates against its trading partners' currencies. Explain the likely effect on the country's terms of trade, and note one reason the effect may differ from the effect on competitiveness. (6 marks)
Step-by-step solution
1. Step 1
  Effect on export prices. An appreciation makes exports dearer in foreign currency, so the foreign-currency price of exports rises.
2. Step 2
  Effect on import prices. The same appreciation makes imports cheaper in domestic currency, lowering the import-price index.
3. Step 3
  Apply the formula. Dearer exports (numerator up) against cheaper imports (denominator down) push the ratio up → the terms of trade improve.
  $\text{Terms of trade} = \frac{\uparrow \text{export prices}}{\downarrow \text{import prices}} \times 100 \Rightarrow \text{ratio rises}$
4. Step 4
  The competitiveness twist. Although the terms of trade improve, dearer exports make the country less price-competitive, so export volumes may fall — the paper 'improvement' can go hand in hand with a worsening current account if demand is elastic.
Answer
An appreciation raises export prices and lowers import prices, so the terms of trade improve — but competitiveness worsens, so an 'improvement' need not help the current account.
Examiner tip
Full marks need the mechanism (appreciation → dearer exports, cheaper imports → ratio rises) AND the evaluation twist that an improvement can coincide with lost competitiveness. Separating the price ratio from the competitiveness/volume effect is the top-level move.
6Examine whether an improvement helps the current account
StretchWord problem• WEC14/01 Section B, Q7(d) style• current account, elasticity, Marshall–Lerner, evaluation, AO4
Question
Examine why an improvement in the terms of trade may not lead to an improvement in the current account of the balance of payments. (8 marks)
Step-by-step solution
1. Step 1
  Set up. An improvement means export prices rise relative to import prices — typically dearer exports and cheaper imports.
2. Step 2
  The elasticity problem. If demand for exports is price-elastic, dearer exports cause a more-than-proportionate fall in export volume, so export revenue falls.
3. Step 3
  The import side. Cheaper imports, if demand is elastic, are bought in much larger quantity, so import spending rises — both effects push the current account towards deficit.
4. Step 4
  Marshall–Lerner link. This is the Marshall–Lerner logic in reverse: when the sum of the price elasticities is high (elastic), a rise in export prices worsens the trade balance.
5. Step 5
  Judgement. So an improvement helps the current account only if demand is inelastic; if it is elastic, the current account can worsen despite the 'improvement'. The label describes the price ratio, not the trade outcome.
Answer
An improvement means dearer exports and cheaper imports; if demand is price-elastic, export revenue falls and import spending rises, so the current account can worsen — the outcome depends on elasticities.
Examiner tip
'Examine' at Unit 4 is KAA-focused, so the developed elasticity chain (dearer exports → elastic demand → revenue falls; cheaper imports → spending rises) lifts it to the top level. Naming the Marshall–Lerner condition shows top-band understanding; concede the inelastic case for balance.

Model Answers — Terms of Trade (Trade and the Global Economy)

High-scoring sample answers for terms of trade (trade and the global economy) on the Pearson Edexcel IAL XEC11 / YEC11 paper, with examiner-style notes mapping each response to the mark scheme and assessment objectives.

Question 1
WEC14/01 Section B, Q7(a) style — Calculate (2 marks)2 marks
[Easy · 2 marks · Section B(a)] A country's index of average export prices is 132 and its index of average import prices is 110 (base year = 100). Calculate the terms of trade. (2 marks)
Model answer
The terms of trade are the index of export prices divided by the index of import prices, multiplied by 100:

$\text{Terms of trade} = \frac{132}{110} \times 100$

$= 1.2 \times 100 = 120$

So the terms of trade are 120. As this is above the base-year figure of 100, export prices have risen relative to import prices — an improvement.
Why this scores
2/2 (AO2): correct method / substitution (1) and the correct value 120 (1). Full working must be shown. Inverting the formula (110 ÷ 132 × 100 = 83.3) is the standard error; noting that 120 > 100 is an improvement secures full credit and sets up any follow-up part.
Question 2
WEC14/01 Section B, Q7(c) style — Explain (4 marks)4 marks
[Easy · 4 marks · Section B(c)] Explain what is meant by an improvement in the terms of trade. (4 marks)
Model answer
The terms of trade measure the rate at which a country's exports exchange for its imports, calculated as the index of average export prices ÷ index of average import prices × 100 (1).

An improvement in the terms of trade is a rise in this figure, which occurs when export prices rise relative to import prices (1) — for example, export prices increasing while import prices stay the same, or export prices rising faster than import prices.

The consequence is that a given quantity of exports now buys more imports than before (1): each unit of exports 'goes further', so the country can obtain more imported goods for the same volume of exports. For instance, a rise in the terms of trade from 100 to 110 means a 10% increase in the import-purchasing power of exports (1).
Why this scores
4/4: definition/formula (1), 'export prices rise relative to import prices' (1), 'a unit of exports buys more imports' (1), and a developed point or example (1). The discriminator is 'relative to' — an improvement is about the price RATIO, not export prices alone. Avoid claiming it is automatically 'good' for the economy.
Question 3
WEC14/01 Section B, Q7(b) style — Analyse (6 marks), Levels 1–36 marks
[Medium · 6 marks · Section B(b)] With reference to a developing economy that depends on commodity exports, analyse how a fall in world commodity prices affects its terms of trade. (6 marks)
Model answer
A developing economy that relies on a narrow range of commodity exports (say copper or coffee) has an index of average export prices dominated by world commodity prices. This makes its terms of trade highly sensitive to swings in those prices.

The mechanism. When world commodity prices fall, the country's index of average export prices falls, while the prices of its imports — typically manufactured goods and fuel — are largely unchanged. Because the terms of trade equal the export-price index ÷ the import-price index × 100, a lower numerator against a steady denominator makes the ratio fall: the terms of trade deteriorate.

What that means for the economy. A deterioration means each unit of exports now buys fewer imports, so the country must export more of its commodity simply to afford the same volume of imports. Its import-purchasing power falls, and — because demand for many commodities is price-inelastic — the price fall may not be offset by higher volumes, so export revenue falls and the current account comes under pressure. This vulnerability to volatile, falling commodity prices is the classic problem of primary product dependency.
Why this scores
6/6 = Level 3 (5–6): a developed chain — commodity price fall → export-price index falls → ratio falls → deterioration → fewer imports per export / falling purchasing power — with accurate use of the formula and a link to primary product dependency. Merely asserting 'the terms of trade fall' without the numerator/denominator mechanism caps at Level 2 (3–4).
Question 4
WEC14/01 Section B, Q7(d) style — Examine (8 marks), Levels 1–38 marks
[Medium · 8 marks · Section B(d)] Examine two causes of a change in a country's terms of trade. (8 marks)
Model answer
The terms of trade change whenever export prices move relative to import prices. Two developed causes follow.

Cause 1 — exchange-rate movements. A change in the exchange rate alters export and import prices simultaneously. An appreciation of the currency makes exports dearer in foreign currency (raising the export-price index) and imports cheaper in domestic currency (lowering the import-price index). Since the terms of trade are the export-price index ÷ the import-price index, a higher numerator against a lower denominator pushes the ratio up, so the terms of trade improve. A depreciation does the reverse, causing a deterioration. Note the twist worth crediting: an appreciation improves the terms of trade on paper yet tends to reduce trade competitiveness.

Cause 2 — changes in world demand and supply for exports (commodity prices). A country's export prices are set in world markets. A rise in world demand for its exports — or a supply shortage — raises export prices and so improves the terms of trade; a commodity boom lifts the terms of trade of oil or metal exporters. Conversely, a glut that increases world supply lowers export prices and causes a deterioration. Because commodity prices are volatile, economies dependent on primary exports experience large swings in their terms of trade.

Both causes work through the price ratio: the exchange rate moves export and import prices together, while world demand/supply moves export prices directly. Their overall impact on the economy then depends on price elasticities.
Why this scores
8/8 = KAA Level 3 (7–8): two developed causes — (i) exchange-rate movements (appreciation → dearer exports, cheaper imports → ratio rises) and (ii) world demand/supply / commodity prices — each traced through the formula. 'Examine' at Unit 4 is KAA-focused, so depth of the two chains secures Level 3; simply listing causes (inflation, exchange rate, productivity) without development caps at Level 1–2. The competitiveness aside shows evaluative awareness.
Question 5
WEC14/01 Section B, Q7(e) style — KAA (8 marks) + Evaluation (6 marks), Levels 1–314 marks
[Hard · 14 marks · Section B(e)] Discuss whether an improvement in the terms of trade is likely to benefit a country's economy. (14 marks)
Model answer
An improvement in the terms of trade is a rise in the ratio of export prices to import prices (export-price index ÷ import-price index × 100), meaning export prices have risen relative to import prices, so a unit of exports now buys more imports. Whether this benefits the economy is not automatic.

The case that it benefits the economy (KAA). Because imports are now relatively cheaper, the country can obtain more imported goods and services for the same volume of exports, raising the real purchasing power of its exports. Cheaper imports of raw materials and consumer goods can ease imported cost-push inflation and lift real living standards — households enjoy more, and firms buy cheaper inputs. If the improvement stems from strong world demand for the country's exports, it may also coincide with higher export earnings and rising national income, supporting growth and government tax revenue.

Why it may not benefit the economy (KAA + evaluation). The improvement means dearer exports and cheaper imports, and the effect on the current account depends on price elasticities of demand:

If demand for exports is price-elastic, dearer exports cause a more-than-proportionate fall in export volume, so export revenue falls. If import demand is elastic too, cheaper imports are bought in far greater quantity, so import spending rises. Both push the current account towards deficit (the Marshall–Lerner logic). A worsening current account can cost jobs in export industries.

The cause matters. If the improvement is driven by a currency appreciation or by higher domestic inflation, it signals a loss of competitiveness, not a genuine gain — the 'improvement' can accompany a weakening economy.

If demand is inelastic, revenue effects are small and the improvement may be broadly beneficial (more purchasing power with little volume loss).

Judgement. An improvement in the terms of trade is beneficial when it raises import-purchasing power without a large loss of export revenue — most likely when demand for exports and imports is inelastic and the improvement reflects strong world demand rather than lost competitiveness. But when demand is elastic, or the improvement is driven by an appreciation or higher relative inflation, it can worsen the current account and signal declining competitiveness. The safest verdict is that an improvement is usually helpful for living standards but not necessarily for the current account — it depends on elasticities and the underlying cause.
Why this scores
14 marks = KAA (8) + Evaluation (6). KAA: accurate definition plus developed chains for the benefits (cheaper imports → purchasing power, eased imported inflation, living standards). Evaluation: weighs elasticity (elastic demand → falling export revenue → current-account deficit, Marshall–Lerner), the cause of the improvement (appreciation/inflation → lost competitiveness) and the inelastic case, reaching a supported, conditional judgement. A one-sided 'improvement is good' answer, or limitations listed without weighing to a conclusion, caps the Evaluation strand at Level 1–2.
Question 6
WEC14/01 Section C style — Evaluate (KAA 12 marks + Evaluation 8 marks), best-fit levels20 marks
[Hard · 20 marks · Section C] Evaluate the view that a deterioration in the terms of trade is always bad for an economy. (20 marks)
Model answer
A deterioration in the terms of trade is a fall in the ratio of export prices to import prices (export-price index ÷ import-price index × 100), meaning export prices have fallen relative to import prices, so a unit of exports now buys fewer imports. The claim to test is that this is always bad — the word 'always' is the weakness to attack.

The case that a deterioration is harmful (KAA). A deterioration reduces the import-purchasing power of a country's exports: it must export more to buy the same volume of imports, so real living standards can fall as imports become relatively dearer, and dearer imported raw materials and energy can generate imported cost-push inflation. For an economy suffering primary product dependency — reliant on a narrow range of commodity exports — a deterioration is especially serious. The Prebisch–Singer hypothesis argues that primary-product exporters face a long-run decline in their terms of trade, because demand for commodities is income-inelastic while manufactures hold their prices; combined with volatile commodity prices, this can destabilise export earnings and government revenue and hold back development. Where demand for exports is inelastic (typical of many commodities), the lower export price is not offset by higher volume, so export revenue falls and the current account worsens.

The case that it is NOT always bad (evaluation). The word 'always' is too strong.

Elasticity can reverse the trade effect. A deterioration means cheaper exports and dearer imports. If demand for exports and imports is price-elastic (Marshall–Lerner satisfied), cheaper exports sell in much larger volume so export revenue rises, while dearer imports are bought less, so the current account can actually improve and support output and jobs in export industries.

The cause matters. If the deterioration is driven by faster productivity growth that lets firms cut export prices to win market share, it reflects improved competitiveness, not weakness — the country gains export volume and market share even as the price ratio falls. Similarly, a deterioration from a depreciation can rebalance an economy running a deficit.

Magnitude and persistence. A small or temporary deterioration (e.g. a short-lived commodity dip that later reverses) may have negligible effects, whereas a large, persistent long-run decline is far more damaging — so severity, not existence, is what matters.

Prebisch–Singer is contested. Commodity 'super-cycles' have lifted primary exporters' terms of trade for years at a time, so the long-run decline is a tendency with exceptions, not an iron law.

Judgement. A deterioration in the terms of trade is not always bad. It is most damaging when demand is inelastic, the fall is large and persistent, and the economy suffers primary product dependency — then living standards and the current account both suffer. But when demand is elastic, or the deterioration reflects rising productivity and competitiveness, or is small and temporary, it can leave the economy no worse or even better off (a stronger current account). The correct verdict is that the effect depends on the price elasticities of demand, the cause of the change, and its size and persistence — so 'always bad' is too strong.
Why this scores
Top level on both strands. KAA (12): accurate definition and developed harms (falling import-purchasing power, imported inflation, primary product dependency, Prebisch–Singer, inelastic commodity demand → falling export revenue). Evaluation (8): rebuts 'always' — elastic demand can improve the current account (Marshall–Lerner), a productivity-driven deterioration signals competitiveness, magnitude/persistence matter, and Prebisch–Singer is contested — reaching a conditional 'depends on elasticity, cause, size and persistence' judgement. The explicit challenge to 'always' and the elasticity/competitiveness counter-cases are the discriminators that push Evaluation to the top level.

Key Formulae — Terms of Trade (Trade and the Global Economy)

The formulae you need to memorise for terms of trade (trade and the global economy) on the Pearson Edexcel IAL XEC11 / YEC11 paper, with every variable defined in plain English and a note on when to use it.

Terms of trade
$\text{Terms of trade} = \frac{\text{index of average export prices}}{\text{index of average import prices}} \times 100$
$\text{index of average export prices}$
the price index for a country's exports (base year = 100) — the numerator
$\text{index of average import prices}$
the price index for a country's imports (base year = 100) — the denominator
When to use
To measure the rate at which exports exchange for imports. The result equals 100 in the base year; above 100 = improvement (export prices up relative to import prices); below 100 = deterioration. It is a ratio of PRICES, not volumes or values.
Example
120 ÷ 100 × 100 = 120 → an improvement (exports buy more imports).
Percentage change in the terms of trade
$\%\,\Delta \text{ ToT} = \frac{\text{ToT}_{\text{new}} - \text{ToT}_{\text{old}}}{\text{ToT}_{\text{old}}} \times 100$
$\text{ToT}_{\text{new}}$
the terms of trade in the later period
$\text{ToT}_{\text{old}}$
the terms of trade in the earlier (base) period — the denominator
When to use
To measure how far the terms of trade have improved or deteriorated between two periods. A positive result = improvement; a negative result = deterioration.
Example
(88 − 100) ÷ 100 × 100 = −12% → a 12% deterioration.

Key Definitions and Keywords — Terms of Trade (Trade and the Global Economy)

Definitions to memorise and the exact keywords mark schemes credit for terms of trade (trade and the global economy) answers — sharpened from recent examiner reports for the 2026 Pearson Edexcel IAL XEC11 / YEC11 sitting.

Terms of trade
Examiner keyword
The rate at which a country's exports exchange for its imports, measured as the index of average export prices divided by the index of average import prices, multiplied by 100 (equal to 100 in the base year).
Improvement in the terms of trade
Examiner keyword
A rise in the terms of trade: export prices rise relative to import prices, so a given quantity of exports buys more imports. It describes the price ratio, not necessarily a gain in welfare or the current account.
Deterioration in the terms of trade
Examiner keyword
A fall in the terms of trade: export prices fall relative to import prices, so a given quantity of exports buys fewer imports. It describes the price ratio, not necessarily a loss in welfare or the current account.
Export price index
Examiner keyword
A weighted index of the average prices a country receives for its exports, set to 100 in a base year; the numerator of the terms of trade.
Import price index
Examiner keyword
A weighted index of the average prices a country pays for its imports, set to 100 in a base year; the denominator of the terms of trade.
Balance of trade
Examiner keyword
The value of a country's exports of goods (and services) minus the value of its imports — a money surplus or deficit. Distinct from the terms of trade, which is a ratio of price indices.
Prebisch–Singer hypothesis
Examiner keyword
The hypothesis that the terms of trade of countries exporting primary products tend to decline over the long run relative to those exporting manufactures, because demand for commodities is income-inelastic while manufactures hold their prices better.
Primary product dependency
Examiner keyword
A situation where an economy relies on a narrow range of primary (commodity) exports, exposing it to volatile export prices and, per Prebisch–Singer, a long-run deterioration in its terms of trade.
Marshall–Lerner condition
Examiner keyword
The condition that a change in relative export/import prices improves the current account only if the sum of the price elasticities of demand for exports and imports exceeds one. It explains why a terms-of-trade change may not move the current account as expected.
Price index
A number measuring the average level of prices relative to a base year set at 100. A value of 120 means prices are 20% above the base year; both export and import prices in the terms of trade are measured this way.
International competitiveness
The ability of a country's goods and services to compete on price and quality in world markets. Note that a terms-of-trade improvement (dearer exports) can coincide with reduced price competitiveness.

Common Mistakes and Misconceptions — Terms of Trade (Trade and the Global Economy)

The traps other students keep falling into on terms of trade (trade and the global economy) questions — taken from recent Pearson Edexcel IAL XEC11 / YEC11 examiner reports and mark schemes — and how to avoid them.

✕Confusing the terms of trade with the balance of trade
WEC14 Examiner Reports — recurring error
Why it happens
Both concern exports and imports, so the terms are easily blurred.
How to avoid it
TERMS OF TRADE = a ratio of export PRICES to import PRICES (an index number, 100 = base year). BALANCE OF TRADE = the VALUE of exports minus the value of imports (a £ surplus or deficit). One is a price ratio; the other is a money value.
✕Assuming an improvement in the terms of trade is always good
WEC14 Examiner Reports
Why it happens
The word 'improvement' sounds unambiguously positive.
How to avoid it
An improvement means DEARER exports and CHEAPER imports. If demand for exports is price-ELASTIC, export revenue falls and the current account can WORSEN. The word describes the price ratio, not the trade or welfare outcome — always bring in elasticity.
✕Treating the terms of trade as a ratio of volumes or values
WEC14 mark schemes
Why it happens
Students think the terms of trade measure how much is traded or the trade balance.
How to avoid it
The terms of trade compare the average PRICE INDICES of exports and imports — not quantities and not values. Volumes and values determine the balance of trade, not the terms of trade.
✕Dividing import prices by export prices (the formula upside down)
WEC14 mark schemes
Why it happens
Students forget which index is the numerator.
How to avoid it
Terms of trade = EXPORT price index ÷ IMPORT price index × 100. Export prices go on TOP. A quick check: if export prices rise relative to import prices the answer should rise ABOVE 100 (an improvement).
✕Thinking a stronger currency causes a deterioration in the terms of trade
WEC14 Examiner Reports
Why it happens
Students link a strong currency to weaker exports and assume the terms of trade must fall too.
How to avoid it
An APPRECIATION makes exports dearer and imports cheaper, so export prices rise relative to import prices → the terms of trade IMPROVE. (Competitiveness may fall, but the price ratio rises — separate the two effects.)
✕Ignoring primary product dependency and Prebisch–Singer in evaluation
WEC14 Examiner Reports
Why it happens
Students describe a terms-of-trade change without linking it to development.
How to avoid it
For commodity exporters, bring in the PREBISCH–SINGER hypothesis (long-run deterioration for primary-product exporters) and PRIMARY PRODUCT DEPENDENCY (volatile earnings, case for diversification) — but treat Prebisch–Singer as a contested long-run tendency, not an iron law.