The terms of trade

Quarterly Bulletin 1987 Q3
Published on 01 September 1987

The evolution of the United Kingdom's balance of external trade depends not only on changes in the volume of goods and services exported and imported but also on the prices at which they are traded. The ratio of export to import prices-the terms of trade-determines the volume of exports necessary to pay for a given volume of imports or, analogously, the volume of imports which can be purchased with the proceeds of a given volume of exports. Other things being equal, if the price of exports falls relative to that of imports (a fall in the terms of trade), the trade balance will deteriorate, and vice versa.

This article first considers alternative measures of the terms of trade and some general influences on them, and then examines the impact of changes in the terms of trade on the current balance and on real national disposable income. Finally, some influences on the terms of trade in manufactured goods in particular are considered: previous articles sought to explain the recovery in the terms of trade in manufactures between 1974 and 1980 in terms of inflation differentials and exchange rate movements; those explanations are reconsidered in the light of the subsequent stability of the terms of trade. In this context the role of profit margins and structural developments in UK industry are examined.

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