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Home Theory of International Trade Gains From International Trade

 

Gains From International Trade:

 

The gains from international trade arise because of the diversity in the conditions of production (natural or acquired) in different countries. Each country tries to specialize in the production of those commodities in which its comparative cost advantage is greatest or the comparative disadvantage is the least. It realizes gain by exporting those commodities which it has a relative advantage over other countries.

 

The gain from international trade can arise only if the opportunity cost ratio between two commodities is different. If the substitute ratio is the same, no advantage can occur to any country. This can be illustrated by taking numerical examples.

 

Example:

 

(1) Equal Difference in Substitute Ratio: Let us suppose in Pakistan one unit of productive resources produces either one quintal of cotton, or half quintal of wheat. Suppose further that India, with one unit of resources is also able to produce either one quintal of cotton or half quintal of wheal. Will specialization or exchange be of any advantage to India and Pakistan? The answer is No. If Pakistan and India invest two units of productive resources separately in their own countries, the total production will be:

 

Pakistan: 1 quintal of cotton + 1/2 quintal of wheat.

 

India: 1 quintal of Cotton + 1/2 quintal of wheat.

 

Total product = 2 quintal of cotton + 1 quintal of wheat without specialization.

 

If Pakistan specializes in the production of cotton and India in wheat the total production will be:

 

Pakistan: 2 quintals of cotton.

 

India: 1 quintal of wheat.

 

When the opportunity cost ratio between two countries is the same, no benefit can occur through specialization to the countries concerned. If Pakistan specializes in the production of cotton and India in wheat, Pakistan will gain only if she can get more than 1/2 quintal of wheat for one quintal of cotton from India.

 

India won't agree to it because in her own country she can get one quintal of cotton for 1/2 quintal of wheat, India can only gain if she pays less than 1/2 quintal of wheat for one quintal of cotton to Pakistan.

 

To this bargain, Pakistan won't agree because by transferring productive resources from cotton to what she can produce that much at home. Thus, we find, that when comparative cost ratio between two countries is the same, no gain can arise from international trade.

 

(2) Difference in Comparative Cost Ratio: When comparative cost ratio in two countries differs, then gain arises from international trade, let us suppose now that with one unit of resource Pakistan produces either one quintal of cotton or 10 quintals of wheat. India with the same resources produces either one quintals of cotton or 25 quintals of wheat. If Pakistan and India invest their resources in their own countries separately for the production of cotton and wheat, the total production will be:

Pakistan: 1 quintal of cotton + 10 quintal of wheat.

 

India: 1 quintal of cotton + 25 quintal of wheat.

 

Total = 2 quintals of cotton + 35 quintals of wheat.

 

If Pakistan specializes in the production of cotton and India in wheat, the total product with the same productive resources will be:

 

Pakistan: 2 quintals of cotton.

 

India: 50 quintal of wheat.

 

We find thus that when opportunity cost ratio is different between two countries, the same productive resources can be made to yield a surplus of 15 quintals of wheat. This surplus of 15 quintals of wheat can be mutually shared by Pakistan and India. If Pakistan's demand for India's wheat is inelastic, terms of trade will be more in India's favor. In case Pakistan's demand for wheat is elastic, then the terms of trade will be more in its favor.

 

Similarly, if India's demand for Pakistan's cotton is inelastic, the terms of trade will move against India. Let us now go back to actual exchange. If Pakistan's demand for India's wheat is inelastic, the rate of exchange will settle somewhere near 11 quintals of wheat for one quintal of cotton and if India's demand for Pakistan's cotton is inelastic, then the rate of exchange will settle somewhere near 24 quintals of wheat for one quintal of cotton. The actual rate of exchange will settle on the intensity of reciprocal demands, and it will remain within two extreme limits, i.e., 10 and 25 quintals.

 

In our example given above, the difference in the cost ratio is small therefore, the gain enjoyed by the trading countries is not much. The greater the difference in the cost ratio, the larger is the total gain. In the words of Harrod:

 

"A country gains by foreign trade if and when the traders find that there exists abroad a ratio of prices very different from that to which they are accustomed at home. They buy what to them seems cheap and sell what to them seems dear. The bigger the gap between what to them seems low point and high point and the more important the article affected, the greater will be the gain from trade. Prof. Ohlin, on he other hand, is of the opinion that the amount of gain from international trade is very complicated. He doubts if the gain from international trade will at all be measured although he does not doubt the existence of such gains".

Relevant Articles:

Home Trade and International Trade
Foreign Trade and National Income
Origin and Purpose of International Trade
Theory of Comparative Cost
Gains From International Trade
Modern Theory of International Trade
Terms of Trade
Advantages and Disadvantages of International Trade
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
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Rent
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Interest
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Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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