Balance of Payment (BOP)

The balance of payment is the statement that files all the transactions between the entities,
government anatomies, or individuals of one country to another for a given period of time. All the
transaction details are mentioned in the statement, giving the authority a clear vision of the flow of
funds.
After all, if the items are included in the statement, then the inflow and the outflow of the fund should
match. For a country, the balance of payment specifies whether the country has an excess or
shortage of funds. It gives an indication of whether the country’s export is more than its import or
vice versa.

Types of Balance of Payment

The balance of payment is divided into three types:
Current account: This account scans all the incoming and outgoing of goods and services between
countries. All the payments made for raw materials and constructed goods are covered under this
account. Few other deliveries that are included in this category are from tourism, engineering,
stocks, business services, transportation, and royalties from licenses and copyrights. All these
combine together to make a BOP of a country.
Capital account: Capital transactions like purchase and sale of assets (non-financial) like lands and
properties are monitored under this account. This account also records the flow of taxes, acquisition,
and sale of fixed assets by immigrants moving into the different country. The shortage or excess in
the current account is governed by the finance from the capital account and vice versa.
Finance account: The funds that flow to and from the other countries through investments like real
estate, foreign direct investments, business enterprises, etc., is recorded in this account. This
account calculates the foreign proprietor of domestic assets and domestic proprietor of foreign
assets, and analyses if it is acquiring or selling more assets like stocks, gold, equity, etc.

Importance of Balance of Payment

A balance of payment is an essential document or transaction in the finance department  as it gives
the status of a country and its economy. The importance of the balance of payment can be
calculated from the following points:

     It examines the transaction of all the exports and imports of goods and services for a given
period.
     It helps the government to analyse the potential of a particular industry export growth and
formulate policy to support that growth.
     It gives the government a broad perspective on a different range of import and export
tariffs. The government then takes measures to increase and decrease the tax to discourage
import and encourage export, respectively, and be self-sufficient.
     If the economy urges support in the mode of import, the government plans according to
the BOP, and divert the cash flow and technology to the unfavourable sector of the
economy, and seek future growth.
     The balance of payment also indicates the government to detect the state of the economy,
and plan expansion. Monetary and fiscal policy are established on the basis of balance of
payment status of the country.

Balance of Trade (BOT): Definition,

Calculations, and Examples
By 
WILL KENTON
 

Updated September 23, 2022

Reviewed by 
MICHAEL J BOYLE
Fact checked by 
YARILET PEREZ
Investopedia / Matthew Collins

What Is the Balance of Trade (BOT)?

Balance of trade (BOT) is the difference between the value of a
country's exports and the value of a country's imports for a given period.
Balance of trade is the largest component of a country's balance of
payments (BOP). Sometimes the balance of trade between a country's goods
and the balance of trade between its services are distinguished as two
separate figures.

The balance of trade is also referred to as the trade balance, the international
trade balance, the commercial balance, or the net exports.

KEY TAKEAWAYS

 Balance of trade (BOT) is the difference between the value of a

country's imports and exports for a given period and is the largest
component of a country's balance of payments (BOP).
 A country that imports more goods and services than it exports in terms
of value has a trade deficit while a country that exports more goods and
services than it imports has a trade surplus.
 Viewed alone, a favorable balance of trade is not sufficient to gauge the
health of an economy. It is important to consider the balance of trade
with respect to other economic indicators, business cycles, and other
indicators.
 The United States regularly runs a trade deficit, while China usually
runs a large trade surplus.
 What's the Balance of Trade?
 Understanding the Balance of Trade (BOT)
 The formula for calculating the BOT can be simplified as the total value
of exports minus the total value of its imports. Economists use the BOT
to measure the relative strength of a country's economy.
 A country that imports more goods and services than it exports in terms
of value has a trade deficit or a negative trade balance. Conversely, a
country that exports more goods and services than it imports has a
trade surplus or a positive trade balance.
 A positive balance of trade indicates that a country's producers have an
active foreign market. After producing enough goods to satisfy local
demand, there is enough demand from customers abroad to keep local
producers busy. A negative balance of trade means that currency flows
outwards to pay for exports, indicating that the country may be overly
reliant on foreign goods.
 Calculating the Balance of Trade
 A country's balance of trade is calculated by the following formula:
 \begin{aligned}&\textbf{BOT}=\textbf{Exports}-\
textbf{Imports}\end{aligned}BOT=Exports−Imports
 Where exports represents the currency value of all goods sold to
foreign countries, as well as other outflows due to remittances, foreign
aid, donations or loan repayments. Imports represents the dollar value
of all foreign goods imported from abroad, as well as incoming
remittances, donations, and aid.
 Debit items include imports, foreign aid, domestic spending abroad, and
domestic investments abroad. Credit items include exports, foreign
spending in the domestic economy, and foreign investments in the
domestic economy. By subtracting the credit items from the debit items,
economists arrive at a trade deficit or trade surplus for a given country
over the period of a month, a quarter, or a year.
 Examples of Balance of Trade
 The United States imported $239 billion in goods and services in
August 2020 but exported only $171.9 billion in goods and services to
other countries. So, in August, the United States had a trade balance of
-$67.1 billion, or a $67.1 billion trade deficit.
 A trade deficit is not a recent occurrence in the United States. In fact,
the country has had a persistent trade deficit since the 1970s.
Throughout most of the 19th century, the country also had a trade
deficit (between 1800 and 1870, the United States ran a trade deficit for
all but three years).1
 Conversely, China's trade surplus has increased even as the pandemic
has reduced global trade. In Aug. 2022, China exported goods worth
$314.9 billion and imported goods worth $231.7 billion. This generated
a trade surplus of $79.4 billion for that month, a drop from $101 billion
the preceding month.2
 Special Considerations
 A country with a large trade deficit borrows money to pay for its goods
and services, while a country with a large trade surplus lends money
to deficit countries. In some cases, the trade balance may correlate to
a country's political and economic stability because it reflects the
amount of foreign investment in that country.
 A trade surplus or deficit is not always a viable indicator of an
economy's health, and it must be considered in the context of
the business cycle and other economic indicators. For example, in
a recession, countries prefer to export more to create jobs and demand
in the economy. In times of economic expansion, countries prefer to
import more to promote price competition, which limits inflation.
 What Is a Favorable Balance of Trade?
 A favorable balance of trade occurs when a country's exports exceed
the value of its imports. This indicates a positive inflow of money to
stimulate local economic activity.
 How Do Changes in a Country's Exchange Rate
Affect the Balance of Trade?
 When the price of one country's currency increases , the cost of its
goods and services also increases in the foreign market. For residents
of that country, it will become cheaper to import goods, but domestic
producers might have trouble selling their goods abroad because of the
higher prices. Ultimately, this may result in lower exports and higher
imports, causing a trade deficit.
 How Can a Country Gain a Favorable Balance of
Trade?
 Many seek to improve their balance of trade by investing heavily in
export-oriented manufacturing or extracting industries. It is also
possible to improve the balance of trade by placing tariffs on imported
goods, or by devaluing the country's currency.
 The Bottom Line
 The balance of trade refers to the net flows of currency in international
markets. A positive balance of trade means that a country is a net
exporter, and sells more goods on the foreign market than it imports. A
negative balance of trade means that the country is a net importer.
 Terms of Trade (TOT) & Balance of Payments (BOP)
 The terms of trade (TOT) measures the rate of exchange of one good or service for
another when two countries trade with each other.
 For international trade to be mutually beneficial for each country, the terms of trade
must lie within the opportunity cost ratios for both country.
 Balance of Payments (BOP)
 The value of a country's exports and imports, and consequently the flows of money into
and out of a country that are recorded in the balance of payments (BOP), is determined
by the quantity of the good or service traded and their prices.
 Changes in the relative prices of exports and imports are important factors in
influencing the values of exports and imports and the balance of payments of a country.
The terms of trade (TOT) is a measure of the relative prices of imports and
exports.
 The coefficient of income elasticity can be calculated by the following formula:
 Terms of Trade index = (Index of Export Prices / Index of Import Prices) x 100
 Improvement of TOT

If the terms of trade index number increases (Px>Pm i.e. export prices are rising

faster than import prices) it is described as a favourable movement (a unit of
exports will buy more imports). In other words, fewer exports have to be given up in
exchange for a given volume of imports.
 Worsening of TOT

If the terms of trade index number decreases (Px<Pm, i.e. import prices rise

faster than export prices) it is described as a worsening or deterioration of the
terms of trade (a unit of exports will buy fewer imports). In other words, a greater
volume of exports has to be sold to finance a given amount of imported goods and
services.
 Movements of TOT & Impact on BOP
 This terminology is somewhat ambiguous as it is important to bear in mind that
a favourable or worsening of a countries TOT does not necessarily mean that
anything is better or worse in term of the balance of payments situation.
Both the price and the quantity of goods traded must be taken into account when
considering the balance of payments situation.
 An increase or favourable change in the TOT index caused by an increase in the price of
exports may bring about a proportionately greater fall in the demand for
exports leading to a worsening of the balance of payments situation.
Conversely, a worsening of the terms of trade index caused by a fall in export prices
may lead to a proportionately greater increase in the demand for exports and
an improvement in the balance of payments.
 It is important to consider how responsive the quantity demanded is to changes in the
price of exports and imports. The price elasticity of demand of exports and
imports is thus crucial.

 Oil Prices and the TOT

 Some developing countries are heavily dependent on exporting oil (which is
generally a price inelastic commodity). Volatility in international commodity
markets create serious problems with these countries’ terms of trade. In the chart
below, notice how closely the annual % change in the terms of trade follows the
movement in oil export prices.

 When oil values collapsed in 1998, these developing countries faced the
enormous problem of having to export much more oil to pay for a given
volume of imports. The worsening in the terms of trade will have adversely
affected living standards in these countries. There has been a sharp rebound in
global oil prices this year, helping to boost the terms of trade for oil exporters.

 Terms of Trade for Developing Countries

 Developing countries which are dependent on the export of commodities and

agricultural produce can be caught in a trap where average price levels for
their main exports decline in the long run. This depressed the real value of
their exports and worsens the terms of trade. A greater volume of exports have to
be given up to finance essential imports of raw materials, components and fixed
capital goods.
  (see REPORT on how TOT have moved for countries in the world over the past
decade)

 The problems intensified in 1998 with the collapse in the currencies of many
Asian developing countries. A big fall in the terms of trade signifies a reduction in
real living standards since imports of goods and services have become relatively
more expensive.

Role of International Organizations (IMF,

World Bank, and WTO)
This article explains the role of the three important international organizations, namely,
World Bank, the International Monetary Fund, and the World Trade Organization in
facilitating trade.

The excerpts of the functions and objectives are taken from their respective websites.

International Monetary Fund (IMF)

The purposes of the IMF are clearly expressed in Article I of its constitution, the Articles
of Agreement:

 To promote international monetary cooperation

 To facilitate the expansion and balanced growth of international trade
 To promote exchange stability
 To assist in the establishment of a multilateral system of payments
 To give confidence to members by making the general resources of the Fund
temporarily available to them under adequate safeguards
 To shorten the duration and lessen the degree of disequilibrium in the international
balances of payments of members

World Bank
The World Bank is a vital source of financial and technical assistance to developing
countries around the world.

We are not a bank in the ordinary sense but a unique partnership to reduce poverty and
support development. We comprise two institutions managed by 188 member countries:
the International Bank for Reconstruction and Development (IBRD) and the International
Development Association (IDA). The IBRD aims to reduce poverty in middle-income
and creditworthy poorer countries, while IDA focuses exclusively on the world’s poorest
countries. These institutions are part of a larger body known as the World Bank Group.

Together these two institutions provide low-interest loans, interest-free credits and
grants to developing countries for a wide array of purposes that include investments in
education, health, public administration, infrastructure, financial and private sector
development, agriculture, and environmental and natural resource management.

World Trade Organization (WTO)

The World Trade Organization (WTO) is the only international organization dealing with
the global rules of trade between nations. Its main function is to ensure that trade flows
as smoothly, predictably and freely as possible.

Where countries have faced trade barriers and wanted them lowered, the negotiations
have helped to open markets for trade. But the WTO is not just about opening markets,
and in some circumstances its rules support maintaining trade barriers — for example,
to protect consumers or prevent the spread of disease.

At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s
trading nations. These documents provide the legal ground rules for international
commerce. They are essentially contracts, binding governments to keep their trade
policies within agreed limits. Although negotiated and signed by governments, the goal
is to help producers of goods and services, exporters, and importers conduct their
business, while allowing governments to meet social and environmental objectives. The
system’s overriding purpose is to help trade flow as freely as possible.

International Trade: Features,

Advantages and Disadvantages of
International Trade
Internal and International Trade:
By internal or domestic trade are meant transactions taking place
within the geographical boundaries of a nation or region. It is also
known as intra-regional or home trade. International trade, on the
other hand, is trade among different countries or trade across political
frontiers.

International trade, thus, refers to the exchange of goods and services

between one country or region and another. It is also sometimes
known as “inter-regional” or “foreign” trade. Briefly, trade between
one nation and another is called “international” trade, and trade
within the territory (political boundary) of a nation “internal” trade.

For all practical purposes, trade or exchange of goods between two or

more countries is called “international” or “foreign” trade.

International trade takes place on account of many reasons

such as:

Human wants and countries’ resources do not totally coincide. Hence,

there tends to be interdependence on a large scale.

2. Factor endowments in different countries differ.

3. Technological advancement of different countries differs. Thus,

some countries are better placed in one kind of production and some
others superior in some other kind of production.

4. Labour and entrepreneurial skills differ in different countries.

5. Factors of production are highly immobile between countries.

In short, international trade is the outcome of territorial division of

labour and specialisation in the countries of the world.

International capital flows are prohibited or severely limited by

different governments. Consequently, the economic significance of
such mobility of factors tends to equality within but not between
countries. For instance, wages may be equal in Mumbai and Pune but
not in Bombay and London.

According to Harrod, it thus follows that domestic trade consists

largely of exchange of goods between producers who enjoy similar
standards of life, whereas international trade consists of exchange of
goods between producers enjoying widely differing standards.
Evidently, the principles which determine the course and nature of
internal and international trade are bound to be different in some
respects at least.

In this context, it may be pointed out that the price of a commodity in

the country where it is produced tends to equal its cost of production.

The reason is that if in an industry the price is higher than its cost,
resources will flow into it from other industries, output will increase
and the price will fall until it is equal to the cost of production.
Conversely, resources will flow out of the industry, output will decline,
the price will go up and ultimately equal the cost of production.

ADVERTISEMENTS:
But, as among different countries, resources are comparatively
immobile; hence, there is no automatic influence equalising price and
costs. Therefore, there may be permanent difference between the cost
of production of a commodity.

In one country and the price obtained in a different country for it. For
instance, the price of tea in India must, in the long run, be equal to its
cost of production in India. But in the U.K., the price of Indian tea may
be permanently higher than its cost of production in India. In this way,
international trade differs from home trade.

(2) Heterogeneous Markets:
In the international economy, world markets lack homogeneity on
account of differences in climate, language, preferences, habit,
customs, weights and measures, etc. The behaviour of international
buyers in each case would, therefore, be different.

(3) Different National Groups:

International trade takes place between differently cohered groups.
The socio-economic environment differs greatly among different
nations.

(4) Different Political Units:

5) Different National Policies and Government Intervention:
Economic and political policies differ from one country to another.
Policies pertaining to trade, commerce, export and import, taxation,
etc., also differ widely among countries though they are more or less
uniform within the country. Tariff policy, import quota system,
subsidies and other controls adopted by governments interfere with
the course of normal trade between one country and another.

(6) Different Currencies:
Another notable feature of international trade is that it involves the
use of different types of currencies. So, each country has its own policy
in regard to exchange rates and foreign exchange.

For the sake of brevity, features of international trade are mentioned

in Chart 1.

Differences between Internal Trade and International

Trade:
Characteristically, there are marked differences between
internal and international trade as stated below:
1. Specific Terms:
Exports and Imports. Internal trade is the exchange of domestic
output within the political boundaries of a nation, while international
trade is the trade between two or more nations. Thus, unlike internal
trade, the terms “export” and “import” are used in foreign trade. To
export means to sell goods to a foreign country. To import goods
means to buy goods from a foreign country.

2. Heterogeneous Group:
An obvious difference between home trade and foreign trade is that
trade within a country is trade among the same group of people,
whereas trade between countries takes place between differently
cohered groups. The socio-economic environment differs greatly
between nations, while it is more or less uniform within a country.
Frederick List, therefore, put that: “Domestic trade is among us,
international trade is between us and them.”

3. Political Differences:
International trade occurs between different political units, while
domestic trade occurs within the same political unit. The government
in each country is keen about the welfare of its own nationals against
that of the people of other countries. Hence, in international trade
policy, each government tries to see its own interest at the cost of the
other country.

4. Different Rules:
National rules, laws and policies relating to trade, commerce, industry,
taxation, etc. are more or less uniform within a country, but differ
widely between countries.

Tariff policy, import quota system, subsidies and other controls

adopted by a government interfere with the course of normal trade
between it and other countries. Thus, state interference causes
different problems in international trade while the value of theory, in
its pure form, which is laissez faire, cannot be applied in toto to the
international trade theory.

5. Different Currencies:
Perhaps the principal difference between domestic and international
trade is that the latter involves the use of different types of currencies
and each country follows different foreign exchange policies. That is
why there is the problem of exchange rates and foreign exchange.
Thus, one has to study not only the factors which determine the value
of each country’s monetary unit, but also the divergent practices and
types of exchange resorted to.

6. Heterogeneous World Markets:

In a way, home trade has a homogeneous market. In foreign trade,
however, the world markets lack homogeneity on account of
differences in climate, language, preferences, habits, customs, weights
and measures etc.

The behaviour of international buyers in each case would, therefore,

be different. For instance, Indians have right-hand drive cars, while
Americans have left-hand driven cars. Hence, the markets for
automobiles are effectively separated. Thus, one peculiarity of
international trade is that it involves heterogeneous national markets.

7. Factor Immobility:
Another major difference between internal and international trade is
the degree of immobility of factors of production like labour and
capital which is generally greater between countries than within the
country. Immigration laws, citizenship qualifications, etc., often
restrict international mobility of labour. International capital flows are
prohibited or severely limited by different governments.

Advantages of International Trade:

The following are the major gains claimed to be emerging
from international trade:
(1) Optimum Allocation:
International specialisation and geographical division of labour leads
to the optimum allocation of world’s resources, making it possible to
make the most efficient use of them.

(2) Gains of Specialisation:
Each trading country gains when the total output increases as a result
of division of labour and specialisation. These gains are in the form of
more aggregate production, larger number of varieties and greater
diversity of qualities of goods that become available for consumption
in each country as a result of international trade.

(3) Enhanced Wealth:
Increase in the exchangeable value of possessions, means of
enjoyment and wealth of each trading country.

(4) Larger Output:
Enlargement of world’s aggregate output.

(5) Welfare Contour:
Increase in the world’s prosperity and economic welfare of each
trading nation.

(6) Cultural Values:
Cultural exchange and ties among different countries develop when
they enter into mutual trading.

(7) Better International Politics:

International trade relations help in harmonising international
political relations.

(8) Dealing with Scarcity:

ADVERTISEMENTS:

A country can easily solve its problem of scarcity of raw materials or

food through imports.

(9) Advantageous Competition:
Competition from foreign goods in the domestic market tends to
induce home producers to become more efficient to improve and
maintain the quality of their products.

(10) Larger size of Market:

Because of foreign trade, when a country’s size of market expands,
domestic producers can operate on a larger scale of production which
results in further economies of scale and thus can promote
development. Synchronised application of investment to many
industries simultaneously become possible. This helps
industrialisation of the country along with balanced growth.

Disadvantages of International Trade:

When a country places undue reliance on foreign trade,
there is a likelihood of the following disadvantages:
1. Exhaustion of Resources:
When a country has larger and continuous exports, her essential raw
materials and minerals may get exhausted, unless new resources are
tapped or developed (e.g., the near-exhausting oil resources of the oil-
producing countries).

2. Blow to Infant Industry:

Foreign competition may adversely affect new and developing infant
industries at home.

3. Dumping:
Dumping tactics resorted to by advanced countries may harm the
development of poor countries.

4. Diversification of Savings:
A high propensity to import may cause reduction in the domestic
savings of a country. This may adversely affect her rate of capital
formation and the process of growth.

5. Declining Domestic Employment:

Under foreign trade, when a country tends to specialize in a few
products, job opportunities available to people are curtailed.

6. Over Interdependence:
Foreign trade discourages self-sufficiency and self-reliance in an
economy. When countries tend to be interdependent, their economic
independence is jeopardised. For instance, for these reasons, there is
no free trade in the world. Each country puts some restrictions on its
foreign trade under its commercial and political policies.

What is terms of trade ? 

The notion of terms of trade refers to the terms or rates at which the products of one country are
exchanged for the products of other country. In other words, it’s defined as the ratio of export prices
to import prices. It is known to all that every country has its own currency & all the currencies are
different with each other. The currency of one country has not legal tender in other countries. So
every country has to export goods in order to import the domestically demanded goods.

 For example, if Pakistan’s wants to import Indian wheat, then he has to export cotton to India. If
Pakistan’s demand for Indian wheat is more intense than India’s demand for Pakistani cotton, then
the terms of trade will be more favorable to India than Pakistan. Similarly, if India’s demand for
Pakistani cotton is more elastic, then the terms of trade will favor India than Pakistan.

What are the factors affecting terms of trade? 

However, there are various factors which affects the terms of trade of a country. They are-

1. Demand Elasticity
2. Elasticity of Supply
3. Nature of Goods
4. Economic Growth
5. Rate of Exchange
6. Trade Restrictions
7. Change in Factor Endowment
8. Change in Technology
9. Population Factor
10. Size of the Country

1. DEMAND ELASTICITY
The elasticity of demand severely affects a country’s terms of trade. If a country’s demand for
imports is more intense or less elastic, then the terms of trade will dis-favor that country. Similarly, if
a country’s  elasticity of  for  imports is less intense or more elastic, then the former gains some
bargaining power &it leads to the improvement in the terms of trade of that country.

2. ELASTICITY OF SUPPLY
Like the elasticity of demand, supply elasticity also affects the terms of trade. When a country’s
supply elasticity increases than its demand, it will positively affect the international terms of trade.
When a country cannot reduce its supply, it de-possesses the power of bargaining & the said
country’s terms of trade start deteriorating.
3. NATURE OF GOODS
When a country exports primary products &imports industrialized products, its terms of trade gets
worsened. It is because the home country cannot complete or bargain with the industrialized
countries. The prices of the primary products  not increases as much as the prices of industrialized
product’s prices. Similarly, if a country exports industrialized products, its chances of improving
terms of trade will increase.

4. ECONOMIC GROWTH
In the process of economic growth, country’s imports increases drastically due to increase in the
purchasing power of the people of that country. Due to this, consumption on importable goods
increases & at the same time, exports couldn’t be matched with the high imports. This leads to the
deterioration of terms of trade of that country.

In the other hand, as economic growth gathers momentum, the cost of production of that country
decreases significantly. It leads to the fall in the price level of exportable goods, but at the same
time, import prices remains constant. This leads to export more quantities of goods to get the same
previous quantity of imports. So economic growth negativity impacts the terms of trade.

Conversely,  if the growth arises in the importable goods industries, then the imports of home
country starts decreasing as home country now started producing the same good domestically. In
this scenario, home country’s terms of trade improves.

5. RATE OF EXCHANGE
The international exchange rates also affects the terms of trade. When a country’s currency
appreciates, it leads to exports costlier & imports cheaper. So appreciation of currency leads to the
improvement in terms of trade. Like wise, when a country’s currency depreciates due to devaluation
or depreciation, its imports gets costlier & exports becomes cheaper. In this case, we have to give
more export goods to get the same previous quantity of imports. So devaluation leads to the
deterioration of terms of trade.

We can understand this concept by a mere example. Suppose the initial exchange rate is fixed
between India & USA as 1 dollar=100 rupees. Suppose there is 1 commodity called leather bags &
each bag costs around 50 rupees. So India gets 1 dollar by selling 2 bag in USA. Now If the Indian
currency devaluates & the new exchange rate fixed as 1 dollar= 150 rupees, then to get the same
Value, i.e., 1 dollar, we have to sell 3 bags to the USA. It leads to our exports cheaper &
consequently it badly impacts the terms of trade

Similarly, if the Indian currency appreciates & new exchange rates fixed as 1 dollar=50 rupees, then
to get same 1 dollar, now we have to provide only 1 leather bag to the USA. Here, our export prices
increases & imports gets cheaper & we can reap the benefit from international trade & consequently
our terms of trade will improve.

6. TRADE RESTRICTIONS
Due to various trade restrictions like tariffs, quotas, etc., the terms of trade improves for the
restriction imposing country. When a country imposes restrictions, it means the country wants to
reduce the imports. When imports reduces, it automatically leads to the promotion of export &
generation of foreign exchange. So restrictions improve the terms of trade.

7. CHANGE IN FACTOR ENDOWMENT

Normally, a labour abundant country produces labour intensive products & exports it and imports
capital intensive product from the capital abundant country.

So, if the factor endowment changes, means due to some reasons, the labour abundant country now
produces capital intensive goods through the movement of capital from one nation to others or due
to the economic growth, the labour abundant country can now bargain with capital abundant country
& reap the trade profit from international trade. It will definitely improve the terms of trade of that
country in which the factor endowment changes.

8. CHANGE IN TECHNOLOGY
Technological improvements continues in the modern world. But its impact on terms of trade may
not always beneficial. If the technical progress arises in the home country’s importable goods
industry, then it improves the terms of trade. On the other hand, if technical progress arises in the
home country’s exportable goods industry, then it deteriorates the terms of trade.

Suppose, technical progress takes place in the importable goods industry. By this, the cost of
production may reduced or the factor’s productivity may increased. In both the cases, the prices of
importable goods decreases in the home country. This leads to the lesser quantity of imports from
foreign country to satisfy the domestic demand & the terms of trade gets improved.

Similarly, suppose the technical progress takes place in the home country’s exportable industry. Due
to this, the cost of production may be reduced or the output per input may be increased. In both the
scenarios, the price of goods in the export industry falls. The fall in the price level brings exports
cheaper than the imports. So technical progress in export industry leads to the deterioration of terms
of trade of the home country.

9. POPULATION FACTOR
The over populated countries always creates problem in the betterment of terms of trade. A huge
population leads to huge consumption demand which cannot be satisfied by the domestic supply of
goods and services. Even to provide basic amenities to the people, a country is forced to import.
Huge imports leads to the deterioration of terms of trade.

10. SIZE OF THE COUNTRY

The size of the country also affects the terms of trade. Always small country gets benefit from the
international trade more than the bigger sized countries. As the size of the country is big, it leads to
the specialization & division of labour which leads to higher productivity and lower cost. The prices of
the goods produced by the big countries are very low. So it exports goods at a cheaper rate.

Likewise, a small country always faces the problem of scarce resources, better & skilled manpower,
better technology etc. Due to the lack of all these facilities, its product’s prices increases. So a small
country always exports goods at a higher rate. When international trade takes place in between a
large country & a small country, the larger country exports goods at a cheaper rate & imports at a
higher rate which deteriorates her terms of trade. Similarly, the small country exports goods at a
higher rate & imports goods at a cheaper rate from the larger country. Due to this, small country
always gets benefitted & improves its terms of trade.