IB Economics Terms of Trade (HL): What You Actually Need to Know

Terms of trade is the ratio between a country's export prices and its import prices, shown as an index against a base year of 100. For HL Economics, you need the formula, how to calculate it from price index data, what shifts it, and how it links to purchasing power, real income and the balance of payments.

The index equals (index of average export prices ÷ index of average import prices) × 100, with the base year set at 100. A figure above 100 means export prices have risen faster than import prices — that's an improvement in the terms of trade. A figure below 100 signals deterioration.

Terms of trade tracks the ratio of export to import prices; balance of trade tracks the actual value of exports minus imports, which depends on both price and volume. A country's terms of trade can improve while its balance of trade worsens, if higher export prices cause export volumes to fall sharply.

Terms of trade improve when export prices rise faster than import prices — from a currency appreciation, stronger demand for your exports, or a jump in commodity prices you export. They worsen with currency depreciation, oversupply of your exports on world markets, or rising prices for the fuel and inputs you import.

Terms of trade is an HL-only topic — it doesn't appear on the SL syllabus at all. It sits within the International Economics unit as one of the HL extension topics, alongside the Marshall-Lerner condition and the J-curve, and it's fair game for Paper 3's quantitative questions.

Terms of trade appears on Paper 3 as a quantitative HL question, usually giving you export and import price indices and asking you to calculate the index, then explain or evaluate a change. Expect it paired with real-world data — a case study on a commodity-exporting country is a favourite examiner set-up.

Terms-of-trade questions on Paper 3 typically use 'calculate' for the index itself, 'explain' for the cause of a stated change, and 'evaluate' or 'discuss' for the wider economic impact. Each command term demands a different depth — a calculate question wants a number and units, not a paragraph of theory.

Students mix up the direction of the ratio (export ÷ import, not the reverse), and confuse a rising index with automatically being 'good news.' In years of marking Paper 3 scripts, the single most common error is students treating terms of trade as a straightforward win-lose measure when it's really about relative prices, not welfare.

The most common mistake is assuming an improved terms of trade always makes a country better off. That assumption ignores what happens to export volumes and the trade balance — a price rise that crushes demand for your exports can leave you worse off even as the index climbs.

No — not automatically. An improved terms of trade means you get more imports per unit of exports, but only if export volumes hold up. If demand for your exports is elastic, higher export prices can cut sales so much that total export revenue and real income actually fall despite the 'improved' ratio.

Terms of trade deterioration describes the long-run tendency for primary-product exporters' export prices to fall relative to manufactured-goods import prices. The Prebisch-Singer hypothesis argues this structurally disadvantages developing countries reliant on commodity exports, since demand for primary goods grows more slowly than demand for manufactures as global incomes rise.

The Marshall-Lerner condition states a currency depreciation improves the trade balance only if the sum of export and import demand elasticities exceeds 1. It connects to terms of trade because depreciation worsens the terms of trade — import prices rise, export prices fall in foreign currency — even as it can improve the trade balance.

Nail the calculation cold — examiners lose HL marks on arithmetic slips more than on theory gaps. Then practise pairing every terms-of-trade number with a real mechanism (a currency move, a commodity shock) and always finish an evaluate question by weighing the price effect against the volume effect on the trade balance.

Yes — for HL Economics, terms of trade isn't optional extra reading; it recurs in the International Economics section of Paper 3 nearly every exam session. It's a compact, calculation-based topic, so it rewards focused, structured practice more than long reading, making it one of the more time-efficient areas to shore up before mocks.