Terms of trade are defined as what?

• A. The ratio of an index of a country's export prices to an index of its import prices.
• B. The rate at which a currency should be exchanged for another.
• C. The total value of exports divided by total value of imports.
• D. The domestic currency’s purchasing power relative to foreign currencies.

Answer: (A)

Terms of trade tells you how favorable a country’s export prices are relative to its import prices. It is defined as the ratio of an index of export prices to an index of import prices. This ratio shows how many units of imports you can buy with the revenue from a given basket of exports. When export prices rise or import prices fall, the terms of trade improve (the ratio goes up), allowing more imports per unit of export revenue. If export prices fall or import prices rise, the terms of trade deteriorate (the ratio goes down). The other ideas pointed to—the rate at which currencies exchange (exchange rate), the simple ratio of total exports to total imports, and a currency’s purchasing power relative to foreign currencies—do not capture the price-based relationship between export and import goods like terms of trade does.