← Macro-economic influences on the New Zealand economy

The terms of trade

A distinct, definable concept that has anchored a whole question on its own (2023) — worth learning as its own idea, not folded into the general exchange-rate discussion.

📖 The terms of trade, precisely

3 terms
Terms of trade
The ratio of export prices to import prices — broadly, how much a country can import for a given quantity of exports. Rises when export prices grow faster than import prices; falls when import prices grow faster.
Favourable movement
The terms of trade RISE: the same volume of exports now buys more imports than before.
Unfavourable movement
The terms of trade FALL: more exports are needed to buy the same volume of imports as before.
Real paper — 2023 Explaining a fall in the terms of trade Export prices rose 3.1% while import prices rose 6.3%. Explain how the terms of trade could have fallen. Both prices rose, so a fall might look surprising at first — the terms of trade compare the RATE of change, not just the direction. Import prices rose by MORE (6.3%) than export prices (3.1%), so the ratio of export prices to import prices falls even though both are rising. Practically: New Zealand now has to give up more exports than before to buy the same quantity of imports — a genuine unfavourable movement despite export prices also increasing. ✓ A fall in the terms of trade needs a comparison of RATES, not just directions — this is the exact trap the 2023 schedule was testing.

What tends to move each side

  • Export prices: global commodity demand, exchange rate movements, and the mix of goods NZ exports (heavily weighted to dairy and other primary products).
  • Import prices: global oil and fuel prices, exchange rate movements, and the cost of manufactured goods NZ does not produce domestically.
  • A depreciation of the NZD tends to raise BOTH import prices (in NZD terms) and, over time, export competitiveness — the net effect on the terms of trade depends on which moves more.
✕

Assuming rising export prices always improve the terms of trade

The terms of trade depend on the RELATIVE movement of export and import prices, not the direction of either alone. Export prices rising is not sufficient to conclude the terms of trade have improved if import prices are rising even faster — always compare the two rates explicitly.

Practise just this