A-Level Economics May/June 2025 Q5(b): Assess whether an improvement in the terms of trade or a surplus on the current account…

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  An improvement in the terms of trade (ToT) occurs when the index of average export prices rises relative to the index of average import prices, meaning a country can acquire more imports for a given volume of exports. A current account surplus occurs when the sum of a country's net trade in goods and services, net primary income, and net secondary income is positive. Both are generally considered desirable, but their relative benefit depends on their cause and context.

  An improvement in the ToT is beneficial as it directly increases a nation's real income and purchasing power. For a given quantity of exports, the country can now afford a greater volume of imports, raising material living standards for consumers and potentially reducing production costs for firms if imported raw materials become cheaper. This can be illustrated by a rightward shift in the Short-Run Aggregate Supply (SRAS) curve, leading to lower inflation and higher real output. For example, if a non-oil-producing country sees the global price of oil fall, its ToT improves, reducing costs across the economy.

  However, the benefit of an improved ToT is conditional on its cause. If it is caused by a rise in the price of its exports, the outcome is ambiguous. While each unit exported earns more, the higher price may reduce the international competitiveness of these exports. If the price elasticity of demand for exports is elastic (PED > 1), then total export revenue will fall, worsening the current account balance and potentially leading to job losses in the export sector. Therefore, an improved ToT is not always beneficial.

  A current account surplus is often seen as a sign of strong economic health. It represents a net injection into the circular flow of income (X > M), which boosts aggregate demand (AD). The rightward shift in the AD curve leads to higher real GDP and lower cyclical unemployment. A persistent surplus, as seen in economies like Germany, indicates strong international competitiveness in key industries, reflecting high productivity and desirable products. Furthermore, a surplus allows a country to become a net creditor, building up its stock of foreign assets which will generate a future stream of primary income.

  Ultimately, a sustainable current account surplus is of more benefit to an economy than an improvement in the terms of trade. While an improved ToT provides a direct boost to living standards via cheaper imports, its overall impact is uncertain and depends heavily on its cause and the elasticity of demand for exports. It can be a volatile and sometimes misleading indicator. In contrast, a current account surplus, provided it does not lead to excessive demand-pull inflation or provoke retaliation from trading partners, is a more robust signal of underlying economic strength, competitiveness, and productive capacity. The benefits of a surplus—economic growth, job creation, and the accumulation of national wealth in the form of foreign assets—are more fundamental and widespread for long-term prosperity than the narrower benefit of increased purchasing power over imports offered by an improved ToT.

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  How it reaches the top band

  • Knowledge / Analysis / Evaluation — The essay demonstrates detailed knowledge by providing precise definitions of both 'terms of trade' and 'current account surplus' in the introduction. The analysis is developed and balanced, exploring the benefits and potential drawbacks of each phenomenon. For instance, it explains the mechanism through which an improved ToT boosts purchasing power but also critically analyses how the cause (e.g., rising export prices) and price elasticity of demand can lead to negative outcomes like a worsening current account. Similarly, it analyses the surplus as a net injection boosting AD and a sign of competitiveness, while also acknowledging potential downsides like demand-pull inflation. The evaluation is the strongest element, running throughout but culminating in the final paragraph. It directly compares the two concepts, weighs their relative importance ('more fundamental and widespread'), considers their interrelationship, and offers a decisive, well-reasoned judgement that a sustainable surplus is 'of more benefit' because it reflects deeper economic strengths like competitiveness and productive capacity, rather than a potentially volatile price change.

  Common ways to drop marks

  • Confusing the terms of trade with the balance of trade (a component of the current account).
  • Providing a purely descriptive answer that lists the benefits of each concept separately without any comparative analysis or assessment.
  • Failing to consider that the cause of the improvement in the terms of trade (e.g., cheaper imports vs. more expensive exports) is crucial to determining its net benefit.
  • Concluding without a clear judgement, or simply stating that 'it depends' without explaining what it depends on and which factor is ultimately more significant.

  Examiner tip: For any 'assess' or 'evaluate' question, ensure your final paragraph makes a clear judgement, directly comparing the options and justifying why one is more significant or beneficial than the other based on the economic reasoning developed in your essay.

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