Business economics Notes

Terms of Trade (TOT)

Terms of trade show the relationship between export prices and import prices, indicating how many imports a country can buy with a given amount of exports.

Importance (any three):

• Improved TOT means the country can import more for the same exports, improving welfare.
• TOT affects foreign exchange earnings and the ability to finance imports (oil, machinery).
• TOT influences trade policy and long-term competitiveness; unfavorable TOT may pressure currency and BOP.

Thus, TOT is an important indicator of a country's trade position and purchasing power in world markets.

The law of variable proportions states that when a variable factor is increased with a fixed factor, output rises at first but later MP falls.

Reasons for diminishing MP (any three):

• the fixed factor becomes a constraint (limited space/machines).
• factor indivisibility and overcrowding reduce efficiency.
• coordination and management problems increase with too many workers.

Hence, after optimum use of fixed input, additional labor adds less output.

Cost-Plus Pricing: Numerical Illustration

Given (example):

• Variable cost per unit = Rs. 60
• Total fixed cost = Rs. 40,000
• Expected output = 2,000 units
• Desired markup = 25% on total unit cost

Step 1: Find fixed cost per unit Fixed cost per unit = 40,000 / 2,000 = Rs. 20

Step 2: Find total unit cost Total unit cost = Variable cost + Fixed cost per unit = 60 + 20 = Rs. 80

Step 3: Add markup Markup = 25% of 80 = Rs. 20

Selling price (cost-plus price) Price = 80 + 20 = Rs. 100 per unit

Mini table:

Suitability/comment:

• Suitable when costs are stable and products are standardized.
• However, it may be unsuitable if demand is weak or competitors offer lower prices; therefore firms should also check elasticity and competition before finalizing price.