Terms of trade worsen from falling export demand

Steps:

• Define terms of trade as export price index divided by import price index.
• Note worsening occurs when export prices fall relative to import prices.
• Identify causes: reduced export demand lowers export prices directly.
• Evaluate options against this definition to find the accurate cause.

Why A is correct:

• Terms of trade formula shows falling export demand reduces export prices, decreasing the ratio and worsening terms of trade.

Why the others are wrong:

• B: Trading partners' interest rate hikes affect exchange rates indirectly but do not directly cause terms of trade to worsen.
• C: No causal link exists between worsening terms of trade and partners lowering interest rates.
• D: Worsening terms of trade reduces purchasing power of exports, leading to trade balance deterioration, not improvement.

Final answer: A