1/16/23, 4:51 PM The Gains from Trade (An Overview)

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The Gains from Trade (An Overview)

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The below mentioned article provides an overview on the gains from

trade.

Nations—developed or underdeveloped- trade with each other because trade is

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In the case of autarky or isolation, benefits of international division of labour do not

flow between nations. It is advantageous for all the countries of the world to engage
in international trade. However, the gains from trade can never be same for all the
trading nations. Some countries may reap a larger gain compared to others. Thus,
gains from trade may be inequitable but what is true is that “some trade is better
than no trade”.

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In simple words, gain from trade refers to extra production and consumption effects
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1/16/23, 4:51 PM The Gains from Trade (An Overview)

The idea of gains from trade was at the core of the classical theory of international
trade propounded by Adam Smith and David Ricardo. According to Smith, the gains
from trade arise form the advantages of division of labour and specialisation—both at
the national and international level. Such advantages arise, according to Smith, due
to the absolute differences in costs. Ricardo goes a step further. He says that trade
contributes “to increase the mass of commodities, and therefore, the sum
of enjoyments…” Ricardo adds that the gain from trade consists in the saving of
cost resulting from obtaining the imported goods through trade instead of domestic
production.

Ricardo’s comparative cost thesis may be applied to establish the existence of gains
from trade. In other words, gain from trade depends on the comparative cost
conditions. Comparative cost doctrine suggests that trade can provide benefit to all
countries if they specialise in the production of those goods and, hence, export them
in which they have comparative advantage.

A country, thus, specialises in production and export in accordance with its

comparative advantage. Ricardo’s trading nations acquire complete specialisation in
production. As a result, global output becomes larger than under autarky. Trade also
enables each country to consume more than under isolation. Thus, there is a
production gain and a consumption gain arising out of international trade. Such gains
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1/16/23, 4:51 PM The Gains from Trade (An Overview)

However, in determining the exact volume of gains from trade, Ricardo’s doctrine is
incomplete. For this, what is required is the determination of the actual terms of
trade or exchange rate at which trade would take place. The rate at which one
commodity (say, export good) is exchanged for another commodity (say, import
good) is called terms of trade. Or what import the export buys is called the TOT. Of
course, export (and, hence, import) varies with the change in TOT.

This concept of TOT was introduced in the literature by J. S. Mill by introducing the
concept of reciprocal demand. By reciprocal demand we mean demand of each
country for the other’s goods. On the basis of the principle of reciprocal demand, Mill
determined a final TOT at which trade between two nations takes place.
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country’s demand for that good. Thus, TOT is an index of measuring a country’s gain
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1/16/23, 4:51 PM The Gains from Trade (An Overview)

from trade. As a result, if a poor, small, less developed country (LDC) trades with a
large, rich, developed country’s (DC) autarkic or domestic cost ratio, then the LDC
will acquire all the gains from trade. If the actual TOT lies between two domestic cost
ratios then gains from trade will accrue to both the countries.

However, gains from trade depend on the :

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i. Relative strengths of elasticity of demand for export and import of goods;

ii. Size of the country;

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1/16/23, 4:51 PM The Gains from Trade (An Overview)

In general, greater the inelasticity in the foreign demand for exports and greater the
elasticity of foreign demand for imports, greater will be the gains from trade.

Further, trade leads to increased competition. Competition enhances efficiency LDCs

gain largely in this competitive world. Improved research and technology of the
developed world flow in these countries. Openness to trade supports technological
upgrading via learning. Evidence on learning and technological up gradation is
observed in many activities, mainly in the manufac­turing and service sectors.

Larger output and productivity increases indeed can occur not only in the
manufacturing sector, but also in other sectors in which technological upgrading of
the advanced countries is embodied. In addition, variety of products becomes
available to con­sumers. All these suggest that trade is an ‘engine of growth’.

However, gains from trade can never be unambiguous for all the countries.
Sometimes, TOT may turn adverse against poor LDCs. Further, trade policy is often
designed by the advanced countries in such a way that it reduces benefits of the LDCs
from trade. Possibly, due to this fact it is said that free trade is better than restricted
trade. Of course, restricted trade has merits too. By imposing a tariff, a poor country
can even improve its TOT and, hence, can obtain benefits from trade.

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