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      Question

      If a country's Terms of Trade (ToT) improve, what is the

      immediate and direct effect on that country's welfare?
      A The relative price of its exports has risen, allowing fewer exports to be given up to obtain a given level of imports. Correct Answer Incorrect Answer
      B The relative price of its exports has fallen, reducing the country's national income. Correct Answer Incorrect Answer
      C The relative price of its imports has fallen, requiring more exports to finance a given level of imports. Correct Answer Incorrect Answer
      D The relative price of its imports has risen, but the country's export volumes must fall to compensate. Correct Answer Incorrect Answer

      Solution

      Solution: The Terms of Trade (ToT) are typically defined as the ratio of a country's export price index to its import price index: ToT= [Export Price Index / Import Price Index ] × 100 · Improvement in ToT: An improvement means the ratio has increased. This can happen if the price of exports rises, or the price of imports falls, or both. · Welfare Effect: When the ToT improves, a country can obtain a greater quantity of imports for any given quantity of exports. This is equivalent to an increase in the country's real income or purchasing power from trade, thus directly improving its welfare. Option C accurately captures this mechanism by stating that the relative price of exports has risen (a cause of improvement), allowing fewer exports to be given up (the beneficial effect on purchasing power).

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