THE GAINS FROM

INTERNATIONAL TRADE

DR. LAXMI NARAYAN YADAV

ASSISTANT PROFESSOR OF ECONOMICS
GOVT. P.G. COLLEGE
MAHENDERGARH
E-mail: laxmi_narayan70@yahoo.com
 OUTLINE

 Definition
 Kind of Gains from Trade
 Sources of Gains from Trade
 Determinants of Gains from Trade
 Measurement of Gains from Trade
 Size of the Country and Gains from Trade
 DEFINITION

Gains from International trade refers to that

advantages which different countries participating
in international trade enjoy as a result of
specialization and division of labour.

The Gains from trade are the benefits from

trading rather than producing i.e. the benefits that
accrue to each country to a transaction over and
above the benefits each would have derived from
producing the goods or services themselves.
 KINDS OF GAINS FROM TRADE

 STATIC GAINS: Static gains are the gains

from the reallocation of factors of production in
sectors where the country has a comparative
advantage. Static gains can be reaped
immediately in the short-run through more
efficient allocation.

 DYNAMIC GAINS: Dynamic gains are those

gains which accumulates over a period of time.
Dynamic gains accrue only over time in less
obvious and direct ways.
 STATIC GAINS FROM TRADE

 Maximisation of Production i.e efficiency

gains from exploiting comparative advantage
 Increase in Welfare
 Increase in National Income
 Reduced Costs from Economies of Scale
 Increased Product Variety
 Vent for Surplus
DYANAMIC GAINS FROM TRADE

 Efficient Utilisation of Resources

 Widening of the Market
 Increase in Saving and Investment
 Educational Effect (Learning by importing
and learning by exporting)
 Checking of Monopolies
 Increase in Competition
 SOURCES OF GAINS FROM
INTERNATIONAL TRADE

 Expansion of the Size of the Market

 Division of Labour
 Gains from Specialisation
 Gains from Increased Product Variety
 Gains from Increased Competition
 Gains from Increased Economies of Scale
 Productivity Gains
 DETERMINANTS OF GAINS FROM
INTERNATIONAL TRADE

 TERMS OF TRADE: Terms of trade refers to the

rate at which the goods of one country are exchanged
for the goods of another country. Country with better
term of trade gains more.

 RECIPROCAL DEMAND: If the demand of a

country for the production of another country is
inelastic, terms of trade will be unfavourable.

 DIFFERENCE IN COST RATIOS: More the

difference in the cost ratios of two countries, more is
the gain from international trade.
…..Cont‟d
 IMPROVEMENT IN PRODUCTIVITY: With
improvement in productivity, costs and prices fall in
both the countries leading to enlargement of
productivity gains.

 STAGE OF DEVELOPMENT: An industrialist

advanced and capital rich country generally enjoys a
larger share of the gain of trade than an
economically backward and labour-abundant
country.

 SIZE OF THE COUNTRY: Inverse relationship

between size of the country and gains from trade. A
smaller country gains more from specialisation.

…..Cont‟d
 NATURE OF EXPORT GOODS: A country
exporting primary goods have adverse term of trade
and gains less from trade whereas a country exporting
manufacturing goods gains more from trade.

 TRANSPORT COSTS: High transport costs

limits the gains from trade. An decrease in
transportation costs increases the gains from trade.

 COMPETITION AND MONOPOLY: Goods

having production in many countries faces more
competition and hence the gains from trade will be
less to the countries exporting these goods.
 MEASUREMENNT OF GAINS FROM
INTERNATIONAL TRADE

 TRADITIONAL VIEW
 Reduction in Production Costs (Ricardo
Approach)
 Terms of Trade (Mills Approach)
 Increase in Real Income

 MODERN VIEW
 RICARDO APPROACH FOR
MEASUREMENT OF GAINS
• Reduction in the total real costs is the basis of
gains.
• A country will export those commodities in which
its comparative production costs are less and will
import those commodities in which comparative
production costs are high.
• The country thus economises in the use of its
resources, obtaining for a given amount thereof a
larger total income than if it attempted to produce
everything at home. The difference between the
two is its gain from trade.
Before Trade: AB is the PPC curve of the country.
Point E indicates equilibrium position before trade.
After Trade: PPC shifts and take the
C shape of BC. Slope of BC shows
international price ratio. Suppose the
A` country is in equilibrium at point F on
F. BC curve, then to produce there it
would have to increase its
A labour such as to shift its PPC
.
E
to A`B`
The amount of
gains from trade
will be BB`/OB
O B B`
X - Commodity
 Malthus criticised that Ricardo has greatly over-
estimated the gains. He argued that F will not be
the equilibrium point. He opined that consumer
will prefer a point right of F on A`B`.
C Findlay has modified gains from
Y - C om m od ity

trade by introducing indifference

A`
curve CI. If the labour input is
A0
F
. increased sufficiently to push
PPC to A0B0 instead of A`B`, the
A

. . G
point G on CI will give equal
satisfaction as in F.
E The amount of
CI
gains from trade
will be BB0/OB
O B B0 B`
X - C om m od ity
 J.S. MILL APPROACH
• The Ricardo analysis does not show the exact
position of quantum of gains and how they are
distributed.
• John Stuart Mill had resolved the problem of how
to exactly reach the rate of exchange in
international market.
• According to Mills it is the reciprocal demand that
actually determines the prevailing terms of trade
and the gains obtained by a particular country.
• In his view import, or in other words, demand,
must be of much more importance than export in
determining the real terms of trade.
• When a country participate trade it firstly takes the
status as a demander. Another status of a trader,
supplier, is just derived there from.
• It is the relative extensibility of reciprocal demand
that actually determines the real terms of trade and
consequently the distribution of possible total gains
from trade between the two trade partners.
• Suppose India has a comparative advantage in
wheat and enormous demand for auto. And U.S.A.
has a comparative advantage in auto and enormous
demand for wheat.
• The equilibrium terms of trade depend on both
Indian demand for auto and wheat as well as U.S.A.
demand for these two goods.
• If the Indian demand for auto is stronger, term of
trade will be close to Indian price ratio. And if the
US demand for wheat is stronger, terms of trade
will be close to US price ratio.
• This can be explained with the help of offer curve.
The offer curve shows the quantities of good X that
country A supplies to the world market for export and
the quantities of good Y that it demands from the
world market as imports, for all prices.
Wheat Wheat
1w=.6AQ T1W=.7A
U.S.A. (Wheat imports)
90 B
A
T M
50 India
60 1A=.7w (Wheat
exports)
P
20 M
1A=.4w

O O
50 90 Auto 30 60 Auto
export=50A, import=20W export=50W, import=30A

OA = U.S.A. Offer Curve ; OP = USA Cost Ratio of Auto

OB = India Offer Curve ; OQ = India Cost Ratio of Wheat
OT = Equilibrium Terms of Trade
 Wheat Q Cost ratio within U.S.A. is KS
R unit of Wheat and OK unit of
auto but it gets KE unit of
A
wheat through trade.
T The gain of U.S.A =
B ES unit of wheat
E
F
Cost ratio within India is KR
unit of Wheat and OK unit of
P auto but it import OK unit of
S Auto from U.S.A. in exchange
for only KE unit of wheat.
O K Auto The gain of India =
ER unit of wheat
 REAL INCOME APPROACH
• Instead of importing goods from abroad, if the same
are produced and consumed within the country,
then the relative loss suffered by the country will
constitute the basis for measuring gains from trade.
This would be maximum gains.

• On the other hand, if the goods received from

international trade are consumed in same ratio as
when the same are produced with in the country,
then the resulting increase in income will be the
minimum gains from trade.

• Real gains from trade is always between these

maximum and minimum gains.
 MODERN APPROACH

 Modern Theory divides the gains from trade into

gains from production and gains from consumption.
 The theory states that the introduction of trade
permits the realisation of gain from exchange and gain
from specialisation.
 Both consumers and producers gain from
international trade by consuming more and producing
more than the pre-trade level.
 The following diagram shows the decomposition
of trade gains into consumption gains and production
gains.
AB = Transformation curve representing supply side.
CI0 = Community Indifference Curve showing demand side
E = Autarky equilibrium (PP is domestic price ratio).
P1= new price line after trade and
P2
P1
steeper than PP.(Y become
relatively cheaper
P
C C = new consumption point after
A trade on higher CI1.

D E The movement from

CI1 E to C measures the
CI0
P gain from exchange
or consumption gains
B
X- Commodity
 Since the price of X has increased in world market,
producers increase its production and decrease that of Y.
 This leads to movement along the transformation curve
from point E to N where international price line P2 is
tangent to AB at N
P2 The new term of trade ratio P2 is the
P1 same as P1 because it is parallel to
C`
P
P1. At N the country export NK of X
Y - C o m m o d ity

C in exchange of KC` imports of Y

A

Consumption moves from

D E C I2
C I1
point C to C`. This
C I0 Movement from C to C`
K N
P measures the gains from
B specialisation in production
X - C o m m o d ity
 Hence the gains from international trade are
maximised at points N and C` because the MRT in
production and MRS in consumption are equal at
international price ratio P2.
 The total gains from trade is the sum of
consumption and production gains and is shown as
improvement in welfare from CI0 to CI2.
 SIZE OF THE COUNTRY AND
GAINS FROM TRADE
 Gains from trade are relatively larger for a small
country.
 Owning to small size, the scope of gains from
specialisation and exchange are limited whereas
large country has scope for both.
 Trade provide an opportunity for the small country to
specialise in the production of those commodities in
which it has comparative advantage and exchange
them in world market.
 The more world market prices differ from domestic
market, more will be its gains.
 IMPORTANT QUESTIONS

 What do you mean by „gains from trade‟ ?

 How are the gains from trade are measured?
 Discuss the relationship between „gains from
trade‟ and „terms of trade‟?
 What are the kind of gains from trade?
 What are the sources of gains from trade?
 What are the factors affecting gains from trade?
 REFERENCES

 M.L. Jhingan, “International Economics” Konark

Publication, New Delhi.
 M. C. Kemp, “The Gains from Trade and the
Gains from Aid: Essays in International Trade
Theory” Routledge.
 Samuelson, Paul A. (1962), "The Gains from
International Trade Once Again," The Economic
Journal 72, pp. 820-829.
 T.R. Jain, O.P. Khanna and Vir Sen “Development
and Environmental Economics and International
Trade” V.K. Publications, New Delhi.