Explain the various concepts of terms of trade. Critically examine the behavior of terms of trade as explained by Prebisch

Terms of trade (TOT) represent the ratio between a country's export prices and its import prices. How many units of exports are required to purchase a single unit of imports? The ratio is calculated by dividing the price of the exports by the price of the imports and multiplying the result by 100.

When more capital is leaving the country then is entering into the country then the country’s TOT is less than 100%. When the TOT is greater than 100%, the country is accumulating more capital from exports than it is spending on imports.

The TOT is used as an indicator of a country’s economic health, but it can lead analysts to draw the wrong conclusions. Changes in import prices and export prices impact the TOT, and it's important to understand what caused the price to increase or to decrease. TOT measurements are often recorded in an index for economic monitoring purposes.

A TOT is dependent to some extent on exchange and inflation rates and prices. A variety of other factors influence the TOT as well, and some are unique to specific sectors and industries.

Scarcity—the number of goods available for trade—is one such factor. The more goods a vendor has available for sale, the more goods it will likely sell, and the more goods that vendor can buy using capital obtained from sales.

The size and quality of goods also affect TOT. Larger and higher-quality goods will likely cost more. If goods sell for a higher price, a seller will have additional capital to purchase more goods.

The Prebisch–Singer hypothesis (also called the Prebisch–Singer thesis) argues that the price of primary commodities declines relative to the price of manufactured goods over the long term, which causes the terms of trade of primary-product-based economies to deteriorate. As of 2013, recent statistical studies have given support for the idea. The idea was developed by Raúl Prebisch and Hans Singer in the late 1940s; since that time, it has served as a major pillar of dependency theory and policies such as import substitution industrialization (ISI).  Prebisch specifically deals with the economic cycle and highlights to a greater extent than Singer the reasons for the different behaviour of wages in developed and underdeveloped countries, and received much greater recognition for his work, in part because of efforts by industrialized countries like the United States to distance themselves from his work.

Assumptions in the Prebisch-Singer thesis:

The main assumptions in the Prebisch-Singer thesis are as under:

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