Terms-of-trade Effects and Real National Income

Abstract

The deflation of imports and exports each by their own price index can produce on occasion results that are confusing to the layman. Thus, for instance, in 1980 UK exports (Pl2) exceeded UK imports (P21) by no less than £4 billion. Yet, upon revaluation of imports and exports at their 1975 prices, this export surplus turns into an import surplus of a little over £1 billion according to the 1982 Blue Book On closer examination we find that this change of sign of the foreign balance (P12-p21) is due to the fact that the United Kingdom in the years between 1975 and 1980 experienced a considerable improvement in its terms of trade with the rest of the world. Actually UK export prices rose by some 90 per cent on average, while UK import prices rose on average by only 70 per cent from 1975 to 1980. Consequently revaluation from 1980 to 1975 prices reduces the value of exports more than the value of imports and this has the effect of turning an export surplus at 1980 prices into an import surplus at 1975 prices.