Is the terms of trade (TOT) explained as the ratio of the value of exports to the value of imports? How does the TOT relate to the exchange rate?
The terms of trade (TOT) is explained as the ratio of price index of export goods (PIX) to the price index of import goods (PIM) times 100, I.e., (PIX/PIM)*100. As both price indexes are based on the prices of domestic currency, so a rise in the exchange rate of domestic currency, i.e., appreciation of domestic currency, will lower the import prices and thus improve the TOT. On the contrary, a fall in the exchange rate of domestic currency, i.e., depreciation of domestic currency, will raise the import prices and thus worsen the TOT.