THE GAINS FROM
DR. LAXMI NARAYAN YADAV
ASSISTANT PROFESSOR OF ECONOMICS
GOVT. P.G. COLLEGE
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
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.
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
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.
KINDS OF 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
STATIC 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
DYANAMIC GAINS FROM TRADE
SOURCES OF GAINS FROM
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
DETERMINANTS OF GAINS FROM
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.
IMPROVEMENT IN PRODUCTIVITY: With
improvement in productivity, costs and prices fall in
both the countries leading to enlargement of
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
SIZE OF THE COUNTRY: Inverse relationship
between size of the country and gains from trade. A
smaller country gains more from specialisation.
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
Reduction in Production Costs (Ricardo
Terms of Trade (Mills Approach)
Increase in Real Income
RICARDO APPROACH FOR
MEASUREMENT OF GAINS
• Reduction in the total real costs is the basis of
• 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.
X - Commodity
Before Trade: AB is the PPC curve of the country.
Point E indicates equilibrium position before trade.
After Trade: PPC shifts and take the
shape of BC. Slope of BC shows
international price ratio. Suppose the
country is in equilibrium at point F on
BC curve, then to produce there it
would have to increase its
labour such as to shift its PPC
The amount of
gains from trade
will be BB`/OB
X - Com m odity
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`.
Findlay has modified gains from
trade by introducing indifference
curve CI. If the labour input is
increased sufficiently to push
PPC to A0B0 instead of A`B`, the
point G on CI will give equal
satisfaction as in F.
The amount of
gains from trade
will be BB0/OB
J.S. MILL APPROACH
• The Ricardo analysis does not show the exact
position of quantum of gains and how they are
• John Stuart Mill had resolved the problem of how
to exactly reach the rate of exchange in
• 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.
50 90 Auto
30 60 Auto
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
U.S.A. (Wheat imports)
Cost ratio within U.S.A. is KS
unit of Wheat and OK unit of
auto but it gets KE unit of
wheat through trade.
The gain of U.S.A =
ES unit of wheat
Cost ratio within India is KR
unit of Wheat and OK unit of
auto but it import OK unit of
Auto from U.S.A. in exchange
for only KE unit of wheat.
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 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
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
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
steeper than PP.(Y become
C = new consumption point after
trade on higher CI1.
The movement from
E to C measures the
gain from exchange
or consumption gains
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
X- Com m odity
The new term of trade ratio P2 is the
same as P1 because it is parallel to
P1. At N the country export NK of X
in exchange of KC` imports of Y
Consumption moves from
point C to C`. This
Movement from C to C`
measures the gains from
specialisation in production
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
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.
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?
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
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.