How is the terms of trade calculated?

The terms of trade serve as an important indicator of a country's economic health, reflecting the relative price of its exports compared to imports. It is calculated by taking the export price index, dividing it by the import price index, and then multiplying by 100. This formula allows one to determine how many units of imports can be obtained for a given quantity of exports, thereby providing insight into trade performance.

When the terms of trade are rising, it typically indicates that a country is receiving more value for its exports relative to what it pays for its imports, suggesting a favorable trade situation. Conversely, a decline in the terms of trade means that a country is getting less for its exports, which could lead to reduced economic welfare.

The other options do not accurately reflect how terms of trade is calculated. The first option suggests an addition of indices, which does not provide the relative pricing structure necessary for these calculations. The third option also inverts the proper relationship between exports and imports, while the fourth option pertains to national income accounting rather than the specific measurement of terms of trade.