Unfavourable terms of trade

Unfavourable Terms Of Trade

Causes:

a)Nature of product : The less developed countries are mainly primary producing countries. Their exports mostly include primary products and their imports include capital goods. On the contrary ,the developed countries produce and export manufactured goods. The terms of trade between primary products and manufactured products are determined against the former and in favour of the latter.

b)Effect of technical progress:The industrial countries keep the whole benefit of their technical progress,whereas the primary producing countries transfer a part of fruits from their own technical progress to industrial nations. This has led to the deterioration of terms of trade of primary producing countries.

c)Market conditions:Export prices in the industrial countries Di not fall as a result of technical progress because the manufacturer operate under monopolistic conditions in product market and they do not operate under competitive condition in the factor market . Thus, benefit of improved technology results in rise in prices and is transfered to consumers on poor countries .

d)Price movements:There is contrast between the behavior of prices in industrial and primary producing countries to different movement of primary products prices and industrial prices over successive business cycle . The prices of primary products have risen in prosperous periods and have fallen during depression period. Thus,over successive cycles,the gap between the prices of the two groups of commodities,and primary producing countries have suffered an unfavourable movement in terms of trade.

e) Disparity in demand:Declining terms of trade of less developed countries is also due to long term Disparity in demand for manufacturers and primary products. In industrial countries,the income elasticity of demand for primary products is inelastic while in poor countries ,the income elasticity of demand for manufactured goods is more elastic. 

f) Backward technology:The less developed countries use backward technology as compared to the developed countries.As a result their relative productivity is low,cost ratio are high, price structure is high. This leads to adverse terms of trade for poor country.

g)Population growth:Most of less developed countries experiences overpopulation and high population growth . As a result,there is high internal demand for goods and low exportable surplus. Moreover the import demand of these countries is highly inelastic. This causes their terms of trade to fall.

h)Lack of import substitutes:Poor countries are greatly dependant on the advanced countries for their imports and have not developed imports substitutes. On the other hand,the advanced countries are not so much dependant on poor countries because they are capable of producing import substitutes. Thus, poor countries have weak position in international trade.

I)Lack of adaptability:Unlike,the advanced countries,the less developed countries cannot quickly adapt their supply of goods which are high in demand and whose prices are rising. The reasons for this are backward technology,market imperfections,immobility of production factors etc. Thus,the terms of trade of less developed countries tend to deteriorate.