The use of TTI is often recommended to correct changes in commodity trade conditions for changes in export volumes. A decrease in the terms of trade may be desirable if it leads to a significant increase in the volume of exports, so that the value of exports increases. As a result, import capacity increases. The terms of trade index for income is intended to measure the net effect of a change in the terms of trade of goods on import capacity or on the purchasing power of exports. However, if the profits from foreign investment increase enough to offset the rise in export prices, LDCs cannot benefit from trade. If export prices fall, but profits from foreign investment also fall accordingly, the country`s situation is not worse, although net exchange rate conditions are unfavourable. It is therefore clear that the distribution of profits from trade cannot be rightly decided solely on the basis of changes in the net trading conditions of trade. Where Tc represents the conditions of trade in goods, P for price, index x for exports and m for imports. The concept of net barter conditions is an inappropriate criterion for explaining the distribution of the benefits of trade between two countries, one of which is advanced and the other less developed.
Suppose that the import price index has increased relatively less than the export price index in the latter. This means an improvement in the terms of trade, and it is concluded that the least developed country benefits from trade. The TOT is used as an indicator of a country`s economic health, but it can lead analysts to draw erroneous conclusions. Changes in import and export prices affect THE TOT, and it is important to understand what caused the price to rise or fall. TOT measurements are often recorded in an index for economic surveillance purposes. Developing countries experienced an increase in their terms of trade during the surge in commodity prices in the early 2000s. They could buy more consumer goods from other countries if they sold a certain amount of commodities such as oil and copper. Taking 1971 as the reference year and expressing both India`s export and import prices at 100, the export price index had risen to 90 by the end of 1981 and the import price index to 110. The terms of trade have changed as follows: Net exchange conditions are based on relative changes in export and import prices during a certain period between the base year and the current year. If this time interval is too short, there can be no significant change in the terms of trade.
On the contrary, if this duration is too long, it is possible that the structure of production and demand in the countries will change considerably, so that comparisons based on export and import prices become irrelevant. Despite its use as a device to measure the direction of the movement of trading profits, this concept has significant limitations. It is calculated by multiplying net trade by the productivity index in the domestic export sector. These are essentially net exchange rate conditions for trade, adjusted for changes in the productivity of export goods. Description: The following map shows how the net terms of trade index (2000 = 100) varies by country. The shade of the country corresponds to the size of the indicator. The darker the hue, the higher the value. The country with the highest value in the world is Venezuela with a value of 339.60. The country with the lowest value in the world is Pakistan with a value of 54.92. Scarcity – the number of goods available for trade – is one such factor.
The more goods a seller offers for sale, the more goods he is likely to sell and the more goods the seller can buy with the capital of the sales. For this reason, Haberler suggested that a country should try to optimize the terms of trade rather than maximize the terms of trade. The terms of trade are optimized at export and import price levels where export earnings are highest, while import spending is as low as possible. According to him, the optimal terms of trade are fully in line with maximizing prosperity. When a country`s export price index falls and the import price index remains the same, net exchange rate conditions deteriorate. Since export prices are lower than import prices, the country will be able to receive a smaller amount of imports in exchange for the exported goods. .