This PPT shows the gains from trade as per the neoclassical trade theory in which both countries are choosing incomplete specialization and free trade as the best policy, Here we explain the gain from trade in the perspective of welfare gain.

1. Neoclassical Trade Theory and Gains
From Trade

2. Drawbacks on ricardian theory of comparative advantage
1. This is a supply side theory
2. In this theory labour is the only primary factor of production
3. Labour is considered to be perfectly mobile within two sectors
4. This model is based on fixed coefficient technology and the law of
constant returns.
5. In Ricardian theory there is no clue about the determination of
equilibrium terms of trade
6. In Ricardian theory it is hard to find the exact volume of gains from trade
7. The theory is based on laissez faire, but that might not be the actual
situation every time

3. The supply side: PPC
• This PPC represents variable
coefficient technology and
imperfect factor mobility i.e.
increasing opportunity cost of X
in terms of Y.

4. The Demand Side: Community
Indifference Map
• Community Indifference curve
(CIC) represents the preference
pattern of a country as a whole
• Set of community indifference
curves is called a community
indifference map.

5. DD-SS Interaction: Equilibrium in
Autarky
• PPC: The possible combinations of
the goods that a country can
produce. (SS side)
• CIC: The preference pattern of the
country (DD Side)
• R- Autarkic Equilibrium
• The autarkic price ratio is
represented by the slope of PPC
and CIC at point- R
• 𝑀𝑅𝑇𝑋𝑌 = 𝑀𝑅𝑆 𝑋𝑌 = −
𝑃 𝑋
𝑃 𝑌
• The country can gain from trade if
• TOT≠−
𝑃 𝑋
𝑃 𝑌

6. Gain from trade: a Graphical explanation
• Slope of 𝑃𝑃1-> Autarkic price ratio
• Slope of 𝑃2 𝑃3-> Int TOT
• 𝑃𝑃1 is flatter than 𝑃2 𝑃3
• So
𝑃 𝑋
𝑃 𝑌
< 𝑇𝑂𝑇
• Country enjoys comp adv in X
• Post trade production point S
• Post trade CPL- 𝑃2 𝑃3
• Post trade consumption equilibrium
– T on Higher IC 𝐼3
• 𝑁1 𝑁2- Import of Y 𝑄2 𝑄1- Exp of X