Export Import Price Index Manual 24. Measuring the Effects of Changes in the Terms of Trade

A terms of trade index is generally defined as an economy’s index of export prices divided by an index of import prices. The implementation of this definition would not warrant a chapter in a textbook or in a Manual: it is more or less straightforward. However, many economists over the years have observed that an improvement in an economy’s terms of trade has effects that are very similar to an improvement in Total Factor Productivity or Multifactor Productivity. Economists have also been interested in quantifying the effects of changing international prices on the real income generated by an economy. Once the discussion of changes in the terms of trade is broadened to include these topics, the original simplicity of the terms of trade index vanishes. Thus the purpose of this chapter is to address the effects of changing international prices on the real income of an economy or a sector of an economy. In order to narrow the topic, only an approach to these measurement problems that is based on economic approaches to producer and consumer theory will be considered.