TRADE, TERMS OF

relationship between the prices at which a country sells its exports and the prices paid for its imports. If the prices of a country's exports rise relative to the prices of its imports, one says that its terms of trade have moved in a favourable direction, because, in effect, it now receives more imports for each unit of goods exported. The terms of trade, which depend on the world supply of and demand for the goods involved, indicate how the gains from international trade will be distributed among trading countries. The concept is also applied to different sectors within an economy (e.g., agricultural and manufacturing sectors). An abrupt change in the terms of trade of a country (e.g., a drastic fall in the price of a primary product that is a country's main export) can cause serious balance-of-payments problems if the country is dependent on the foreign exchange earned by its exports to import its manufactured goods and capital equipment. Many theories have been postulated to explain movements in the terms of trade, but none of them is really confirmed by close examination of trade statistics. One of the more popular and politically important beliefs is that the terms of trade tend to move against the less developed countries because their exports consist predominantly of primary products and their imports are largely of manufactured goods from the developed countries.