IB Econ Chap 26 Terms of Trade - Sunny Hills High School

!!!!
26 . Terms of trade
Agricultural policies in developed countries have had a
damaging effect on world agricultural markets. Price support
schemes in the EU and the US, for example, have led to
relatively high prices there and over-production by domestic
producers. These subsidies have also led to over-production.
The over-production is then sold on the world markets, pushing
down agricultural prices. For these reasons, developing
countries often accuse the developed economies of "dumping"
agricultural products on the world market and so ruining their
own agricultural industries.
With huge leaps in technology over the last 50 years, many
products have become smaller. For example, computers that once
took up a whole room are now replaced by laptop computers of
the same power; large tape recorders, the size of a suitcase, are
now replaced by MP3 players the size of a cigarette lighter; and
televisions, which were once housed in large cabinets, are now
replaced by flat screens that require no such housing. This
rniniaturisation of many products and the improvement in
plastics technology has led to a fall in the demand for the
commodities that were traditionally used to make and package
these products.
The effect of the above factors on the average price of commodities
over time is shovrm in Figure 26.3.
We would not want to imply that there has been a fall in demand
for commodities. However, the combination of low income elasticity
of demand, the increased use of synthetic substitutes, and
miniaturisation have led to relatively small increases in demand,
shown as a in Figure 26.3. Improvements in technology along with
the agricultural policies in more developed countries have resulted
in large increases in supply, showr as b in Figue 26.). The result is
that average commodity prices have fallen. This is highlighted in
Figre 26.4.
Given that the TOT index is based on a weighted average of export
prices, those countries that are dependent on commodities will see a
fall in the index of their export prices and deterioration in their terms
of trade.
The deterioration in their TOT resr ts in depreciating current account
deficits. This is because the demand for commodities tends to be
inelastic. For example, although the dernand for copper from Zambia
is likely to be elastic as there are alternative sources of copper,
demand for copper as a whole is inelastic as it is a necessary mineral
in production with few substitutes. This can be said about most
commodities. If you refer back to the revenue box diagram you drew
in workpoint 26.2, you will see that the fall in average export prices
when demand is inelastic results in a fall in expon revenues.
We should also look at the eIlect on imports. with falling export
prices, the price of imports has risen relative to the price of erT)orts.
The goods that developing countries need to import are necessities
such as raw materials, components, and other capital goods. Because
these are not available domestically and are required for economic
.9
E
E
0Qa,
Quanlity of commodities
FiBure 26.3 Falling world commodity
prices
lndexr 1995:loo
25O r
200
r50
100
50+
ti1ure 26.4 Falling commodity prices
a: synthetics ar,miniatuisation
b = lmprovin8
technology and
proteclionism