Brief Notes on Income Terms of Trade (ITT)

G.S. Dorrance has improved upon the concept of net barter terms of trade by formulating the concept of income terms of trade. Income terms of trade refer to the ratio between the values of exports to the import prices.

In other words, income terms of trade are the net terms of trade multiplied by volume of exports. Symbolically,

Q_x = NBTT.Q_x

The income terms of trade indicate nation’s capacity to import because P_x Q_x/P_m determines the volume of imports (O_m) that a country can obtain with the export earnings. The concept of income terms of trade has two major drawbacks:

(i) The income terms of trade indicate only the export-based capacity to import and not the country’ total capacity to import. The total capacity to import depends upon factors like capital inflow, receipts from invisibles, and unilateral payments.

(ii) A change in the income terms of trade need not necessarily reflect the real gains from trade. Even when export prices fall and import prices remain constant, the income terms of trade will improve, if the physical volume of exports increases more than in proportion to the fall in export prices.