The rate at which one country’s goods exchange against those of another is referred to as the Terms of Trade. Terms of trade depend on the prices of commodities entering into foreign trade.

Thus, terms of trade express the relation between export prices and import prices and are said to be favourable to a country when the prices of its exports are high relatively to the prices of its imports. When a country’s prices of imports are high relatively to its export prices, the terms of trade are obviously unfavourable to that country.

Net Barter Terms of Trade

The ratio between the prices of exports and imports is called the net barter terms of trade or as Viner puts it, “the commodity terms of trade.” To express this symbolically:



T stands for net barter terms of trade,

P stands for price index,

x for exports, and


m for imports.

When, however, we want to compare changes in terms of trade between two periods, the following ratio is applied:

where subscripts 1 and 0 stand for time, current year and base year respectively.

Here in the base year pm each of the two index numbers (or prices of exports and imports)


Now, if in the current year, the export price index is 160 and the import price index is 120, then the terms of trade will be:

This means, in the current year, the terms of trade show an improvement of 50 per cent. It follows that if export prices rise relative to import prices, the terms of trade rise or move favourably to the country. If import prices rise relative to export prices over a period of time, the terms of trade will fall or become unfavourable to the country.

The concept of net barter terms of trade has come to be widely accepted as a useful device for measuring short-term changes in trading positions. Further, it serves as an important index expressing the purchasing power of exports in paying for imports.

It is obvious that when a country’s terms of trade improve, less of its real product exported will be able to purchase a given unit of real product of the rest of the world and vice versa.


However, the main drawback of this concept of terms of trade is that it reveals nothing about the behaviour of the balance of payments, as it ignores the quantum of trade.