Business Economics · International Trade

Gains from Trade and Terms of Trade: CA Foundation Business Economics

Q: What is the formula for net barter terms of trade?

NBTT = (Export price index ÷ Import price index) × 100. Both indices must use the same base year. A value above 100 shows improvement from the base year.

Q: What are the main types of terms of trade?

The main types are net barter (commodity), gross barter, income, single factoral and double factoral terms of trade. Each measures a different aspect of the exchange, such as price, quantity, import capacity or productivity.

Q: What are the gains from international trade?

Trade lets countries specialise by comparative advantage, which raises total output and consumption. It also gives wider choice, access to cheaper inputs, larger markets, economies of scale and technology spread.

Q: Do terms of trade decide how gains are shared?

Yes. The closer the exchange ratio is to a country's own domestic cost ratio, the smaller its share of the gains. The ratio must lie between both countries' domestic ratios for both to gain.

Updated 1 October 2026 · Fact-checked

Gains from trade are the extra output and consumption countries get by specialising in what they produce at lower opportunity cost and exchanging. Terms of trade measure the rate at which exports swap for imports. Net barter terms of trade = (Export price index ÷ Import price index) × 100. A rise means a favourable change.

Understand Gains from Trade and Terms of Trade

A country does not need to be the best at everything to gain from trade. It gains by producing what it gives up least to make, and buying the rest from others. This is the idea of comparative advantage: lower opportunity cost, not just lower absolute cost.

When two countries specialise and trade, total world output can rise. Each country can then consume a combination of goods that it could not reach on its own. Other benefits include wider choice for consumers, access to cheaper inputs, larger markets for producers, economies of scale, and spread of technology and competition.

Gains from trade depend on how the trade is shared. The terms of trade show the rate at which a country's exports exchange for its imports. They fix how the gains are divided between the trading partners. Trade is mutually beneficial only if the exchange ratio lies between the two countries' domestic opportunity cost ratios.

The most tested measure is the net barter terms of trade (NBTT), also called the commodity terms of trade. It is the ratio of export price index to import price index, times 100. If it rises, each unit of exports buys more imports, which is usually seen as favourable. Other measures are the gross barter terms of trade (quantity index of imports ÷ quantity index of exports × 100), the income terms of trade (NBTT × export quantity index ÷ 100, which shows import capacity) and the single factoral and double factoral terms of trade, which adjust for productivity.

A rise in NBTT does not always mean greater welfare. If export volumes fall sharply, total gain can drop. That is why income terms of trade are also used.

Key formulas to remember

Net barter (commodity) terms of trade: NBTT = (Px ÷ Pm) × 100; Px = export price index, Pm = import price index, same base year. Above 100 means improvement from the base year.
Gross barter terms of trade: GBTT = (Qm ÷ Qx) × 100; Qm = import quantity index, Qx = export quantity index. Compares volumes, not prices.
Income terms of trade: ITT = (Px ÷ Pm) × Qx; With indices, ITT = NBTT × Qx ÷ 100. Shows the capacity to import from export earnings.
Single factoral terms of trade: SFTT = (Px ÷ Pm) × Zx; Zx = export productivity index. Adjusts NBTT for productivity in export industries.
Double factoral terms of trade: DFTT = (Px ÷ Pm) × (Zx ÷ Zm); Zm = productivity index of import-producing industries abroad.
Limits of mutually beneficial terms: Lower domestic opportunity cost of a good < terms of trade < higher domestic opportunity cost of the same good; The terms of trade must lie strictly between the two countries' domestic opportunity costs of the same good. The exporter, who has the lower cost, gets more than its own cost and pays less than the partner's cost. Measure both costs for the same good in the same units.

How to solve Gains from Trade and Terms of Trade questions

Use this order for any MCQ on gains from trade or terms of trade.

1Identify what is asked: a concept (comparative advantage, type of terms of trade) or a numerical value.
2For a numerical question, note the base year and the index values for exports and imports. Check that both indices share the same base.
3Pick the correct formula: prices give NBTT, quantities give GBTT, and NBTT with export volume gives income terms.
4Substitute carefully, with exports in the numerator for NBTT and imports in the numerator for GBTT.
5Interpret the result: above 100 is favourable, below 100 is unfavourable compared with the base year.
6For gains questions, find each country's opportunity cost per good and the lower-cost producer. Check that the trade ratio lies between the two cost ratios.
7Match your answer with the options and eliminate any that reverse the numerator and denominator.

Quickest way: Ratio check and option elimination

When to use it: Use for numerical NBTT, GBTT and income terms questions, and for comparative advantage questions in an objective paper.

Write the formula in one line before calculating.
Round the numbers to quickly estimate: if export prices rose 20% and import prices 10%, NBTT is about 1.20 ÷ 1.10 × 100 ≈ 109, so remove options far from this.
Check direction: if export prices rose more than import prices, the answer must be above 100.
For comparative advantage, compute only the opportunity cost of one good for each country. The lower one has the advantage in that good.
Skip long multi-step productivity questions if the first pass shows no clear formula, given the 0.25 penalty for a wrong answer.

Common mistakes in Gains from Trade and Terms of Trade

Putting import price index in the numerator of NBTT.
Students mix NBTT with GBTT, where imports come first.
Fix: Remember: price ratio is export over import. Quantity ratio (gross) is import over export.
Treating a higher NBTT as always better for welfare.
Students ignore the fall in export volume.
Fix: Say 'usually favourable'. Use income terms of trade when volume changes matter.
Confusing absolute advantage with comparative advantage.
Students compare input costs instead of opportunity costs.
Fix: Compute what is given up of the other good. Gains exist even if one country is better at both goods.
Comparing indices that have different base years.
Students rush and use the numbers as given.
Fix: Check the base year first. Indices must share the same base before dividing.
Choosing a trade ratio outside the two opportunity cost ratios.
Students forget the condition for mutual gain.
Fix: The ratio must lie between the two domestic ratios. Otherwise one country gains nothing from trade.

Worked examples

Example 1

A country's export price index is 150 and its import price index is 120, both with the same base year. Its net barter terms of trade are: (a) 80 (b) 125 (c) 150 (d) 180

Show the solution

NBTT = (Px ÷ Pm) × 100.
Substitute: (150 ÷ 120) × 100.
150 ÷ 120 = 1.25, so NBTT = 125.
125 is above 100, so the terms of trade have improved.

Answer: (b) 125

Example 2

Over a period, a country's NBTT is 120 and its export quantity index is 90. Its income terms of trade index is: (a) 75 (b) 108 (c) 120 (d) 133

Show the solution

Income terms of trade = NBTT × Qx ÷ 100.
Substitute: 120 × 90 ÷ 100.
120 × 90 = 10,800; 10,800 ÷ 100 = 108.
So import capacity rose by 8% from the base even though export volume fell.

Answer: (b) 108

Example 3

In country A, 1 unit of cloth costs 2 units of wheat; in country B, 1 unit of cloth costs 4 units of wheat. Which exchange ratio gives gains to both countries from trade in cloth and wheat? (a) 1 cloth = 1 wheat (b) 1 cloth = 3 wheat (c) 1 cloth = 5 wheat (d) 1 cloth = 2 wheat

Show the solution

Opportunity cost of 1 cloth is 2 wheat in A and 4 wheat in B.
So A has a comparative advantage in cloth, as its cost is lower, and will export cloth.
A gains only if it gets more than 2 wheat per cloth. B gains only if it pays less than 4 wheat per cloth.
The ratio must lie strictly between 2 and 4 wheat.
Check options: 1 and 5 are outside the range, 2 is the boundary with no gain to A, 3 is inside.

Answer: (b) 1 cloth = 3 wheat

Exam tips

Learn the NBTT formula exactly. Most numerical questions are a one-line division.
Memorise the list of terms of trade types with one-line definitions. Match-the-following questions are common.
For comparative advantage, compute opportunity cost per unit of one good only. It saves time.
Read whether a question asks about price, quantity or earnings, then choose NBTT, GBTT or income terms.
If two options differ by reversing a ratio, check the numerator carefully before marking.

Practice questions from International Trade

Gains from Trade and Terms of Trade: frequently asked questions

What is the formula for net barter terms of trade?

NBTT = (Export price index ÷ Import price index) × 100. Both indices must use the same base year. A value above 100 shows improvement from the base year.

What are the main types of terms of trade?

The main types are net barter (commodity), gross barter, income, single factoral and double factoral terms of trade. Each measures a different aspect of the exchange, such as price, quantity, import capacity or productivity.

What are the gains from international trade?

Trade lets countries specialise by comparative advantage, which raises total output and consumption. It also gives wider choice, access to cheaper inputs, larger markets, economies of scale and technology spread.

Do terms of trade decide how gains are shared?

Yes. The closer the exchange ratio is to a country's own domestic cost ratio, the smaller its share of the gains. The ratio must lie between both countries' domestic ratios for both to gain.