Gains from Trade

III Sem MA- ECO

World Trade Data - Exports

YEAR SERVICES MERCHANDISE Ratio of Trade

($ Billion) ($ Billion) to GDP
1995 1179 5168 20%
2005 2516 10509
2014 4872 19002 30%
 1. Trade & Growth-

Ricardos Comparative Cost Theory

Production resources required
(Number of labour units needed to produce one kg of sugar and one
standard computer chip)
BRAZIL USA

Computer 600 150

Chips
Sugar 6 3
Exchange 100:1 50:1
Ratio
(kg/chip)

Trade increases production efficiency

and contributes to growth
2. Trade & Efficiency: Economies of
Scale
Trade - Markets go beyond the limits
of domestic economy
So trade enables industry to expand
production - economies of scale - the
average cost of the industry's
products will fall i.e. increased
efficiency
 3. Trade ensures benefits of
competition
When nations open up their frontiers to trade
domestic industries forced to compete with goods
and services produced abroad
Domestic industry struggles to become
competitive and pass on cost reductions to
consumers in the form of lower prices.
Very much applicable to industries which tend to
be monopolistic or oligopolistic because of the
nature of the production process (e.g. presence of
big entry costs, large economies of scale,
dependence on a specialized input in short supply)
Eg: Car and Telecommunication industries
 Trade and access to goods - the diversification argument

4. Trade and access to goods - the diversification argument

Trade makes an array of goods and

services accessible to national
consumers
Consumers wider choice of products
 5. Trade and fluctuations - the stability
argument

Trade helps to smooth out transitory

excess demand or excess supply
situations in domestic markets, thus
avoiding or reducing price fluctuations
and eventual supply shortages
Eg: High agricultural production fall in
domestic prices but product has
inelastic demand International market
provides an outlet to dispose surplus
and prevents price disruptions
STATIC GAINS DYNAMIC GAINS
1. Expansion in Production 1. Technological Development
2. Increase in Welfare 2. Increased Competition
3. Rise in NI 3. Widening of Market
4. Vent for Surplus 4. Increase in Investment
5. Efficient use of Resources
6. Stimulus to Growth
 Determinants of Gains of Trade
Determinants Impact
1. TOT Favourable TOT- larger gains from trade & vv
2. Differences in cost Nations A ( cloth) & B ( steel) specialize in goods in which
ratio they have comparative advantage relatively greater fall in
the cost of cloth in A than in steel in B- greater gain in trade
to A
3. Reciprocal Demand Demand for As export cloth is less elastic in B, so B will offer
i.e. elasticity of demand more steel for 1 unit of cloth As TOT improves
4. Level of Income Strong & permanent demand for goods export earnings rise,
demand for labour and money wages rise
5. Productive efficiency As production efficiency goes up cost and product prices
decline B imports at lower prices- TOT of B improves
6. Factor endowments Capital rich and technologically advanced economies have
and Technological larger volume of trade higher gains
conditions
7. Nature of products Exporters of primary goods Unfavourable TOT Gain falls
exported
8. Size of the country Small country small domestic market trade enables in
specialization in goods with comparative advantage gain
from trade rises