Gains from trade

Q.1 EXPLAIN THE VARIOUS GAINS FROM INTERNATIONAL TRADE.

ANS. GAINS FROM INTERNATIONAL TRADE

• INTRODUCTION :

At present, all the countries of the world are open and interdependent. They enjoy the benefits arising out of international trade.

International trade occurs due to differences in prices of goods and services in different countres.

The price differences are a result of differences in cost of production which occur due to differences in factor prices. Now, each country specializes in production of those goods and services which it can produce at a lower cost of production. This gives rise to exports.

Also, each country imports those goods and services which are available at a lower price in other countries.

Thus, there are various gains that countries enjoy by participating in international trade

• GAINS FROM INTERNATIONAL TRADE :

The following are the different gains arising out of INTERNATIONAL  TRADE :

1)      GAINS FROM COST DIFFERENCES :

Gains from cost differences ( or terms of trade ) refer to the exchange ratio of export and import of goods. In fact, it is the ratio of prices of a countries.

• Exports and its imports.

The terms of trade improve when price for exports increases or price for imports decline.

In fact,  Adam Smith stated that a country can enjoy benefits from international trade if it specializes in the production of those goods in which it has absolute cost advantage. David Ricardo suggests that a country should specialize in production of those goods in which it has greater comparative cost advantage

The following examples illustrate the gains from trade due to cost differences :

Eg. 1) 10 days labour produce 10 machines in the U.S.A. 10 days labour produce 2 such machines in India Assume that international exchange rate is 1 unit of machine for 2 units of cloth.

LABOUR

COUNTRY

MACHINES

CLOTH

DOMESTIC EXCHANGE RATE

MACHINES

CLOTH

10 DAYS

U.S.A

10

10

1:

1

10 DAYS

INDIA

2

8

1:

4

At the given international exchange rate :

• U.S.A ‘s  gain Against}  it get 2 units of cloth against 1 unit

1 unit of machine}       of cloth ( at home ) .(i.e. it exports 1 machine against import of 2 cloths)

• India's gain against 1 unit}  It gives 2 units of cloth against 4 units of cloth (at home)

Of machine }                          (i.e. it imports 1 machine by giving only 2 cloths)

This shows that by exporting 1 unit of machine the U.S.A gets 2 units of cloth whereas it gets only 1 unit of cloth at home against 1 unit of machine.

Similarly, India has to give only 2 units of cloth for 1 machine against 4 units of cloth at home.

Eg. 2:

India and japan are the countries involved in trade the commodities include spices and wheat :

Commodity

India

Japan

Comparative cost ratio

Spices (s)

20

40

20/40=0.50

Wheat (w)

40

50

40/50=0.80

Domestic exchange rate

13=0.50w

13=0.80w

In the above example India has absolute cost advantage in both the commodities. However, it has greater comparative cost advantage in terms of producing spices.

Assume that International  Exchange rate = 15= 1w, then

INDIA's gain = 0.5 units

JAPAN's gain = 0.2 units

2)    INCREASE IN WORLD PRODUCTION :

International trade is based on  international division of labour, thus, world production increases due to specialization.

Eg. Let us take an example to understand the increase in total production due to international trade :

COUNTRY

LABOUR

PRODUCTION

OUTPUT

CLOTH

MACHINES

INDIA

10 DAYS

20

4

24

U.S.A

10 DAYS

20

20

40

TOTAL

40

24

64

Thus in 10 days, the total production of both countries is 40 units of cloth and 24 units of machines.

Thus, comparatively, India has an advantage for production of cloth and U.S.A. for machines.

If they go for specialization, the picture will be thus :

COUNTRY

LABOUR

PRODUCTION

OUTPUT

CLOTH

MACHINES

INDIA

10 DAYS

40

-

40

U.S.A

10 DAYS

-

40

40

TOTAL

40

40

80

Thus both countries together produce 16 units more even though they don't go for complete specialization, they together will eventually produce more than  they would produce individually in absence of trade international trade enables developing nations to get the benefits of technological progress in developed countries through import of technical know how and technologically.

Superior capital goods

Developed countries benefit through international  trade by importing raw materials and labour intensive products from developing nations.

3)      INCREASE IN CONSUMPITION :

International trade increases world production. As a result, the consumption of the people of the countries participating in international trade also increase this leads to economic welfare of the people.

Illustration :

Pg 161. FiG 14.1

DIGRAM

Explaination –

pre-trade situation : AB=   Production possibility curve  for commodities ‘x' and ‘y'

E = equilibrium position.

Post – trade situation : CB = international price line

S= community indifference curve

A,B, = additional resources

Result : Larger combination of good XY. Thus, international trade leads to higher level of consumption

4)      HIGHER ECONOMIC WELFARE :

International trade enhances world production due to specialization. This leads to additional consumption. Consumers are able to reap the benefits of superior quality goods at reduced prices.

These is enhancement of consumer welfare.

Illustration : pg 162, FIG 14.2

DRAW FIGURE A

Explaination :

FIG A: CLOSED ECONOMY

AB= production possibility curve for commodities x& y

PP = commodity price ratio

C = community indifference curve

DRAW FIGURE B

FIG B : INTERNATIONAL TRADE

P1P1 =  International price line

CI2 =community indifference curve

E2 = new equilibrium ( international )

Result : movement from E1 to E2 = gain due to consumption.

P2P2  =new international price line

R = new equilibrium ( price of x increased ) (at home )

E3 = new equilibrium (international )

CI3 = new community indifference curve .

Result : movement from CI1 to CI3= increase in community's welfare.

1)    EMPLOYMENT GENERATION :

International trade creates employment opportunities through out the world.

Due to increased production there is enhancement in employment opportunities in the production and distribution sectors.

Increase in employment increases the purchasing power of the people that leads to higher standard of living

2)    INVESTMENT OPORTUNITIES :

international trade encourages inter – regional investment, intra – regional investment as well as domestic investment by participating countries.

Developed nations invest more capital in developing nations. Also, international borrowings ( in the  form of internal debts ) can be repaid due to better earning capacity on account of international trade.

3)    HEALTHY COMPETITION :

international trade improves the efficiency of the firms of participating countries due to healthy competition.

Also, international organizations encourage trade with less or no restrictions. This further enhances healthy competition among firms across the world.

4)    DYNAMIC GAINS:

Technological upgradation, cost- saving techniques, innovation etc are the dynamic gains occurring on account of international trade.

These dynamic gains are brought about in fields of agriculture, industry as well as service sectors.

5)    GAINS ON THE BASIS OF RECIPROCAL DEMAND

‘ Reciprocal demand ‘ is the strength and elasticity of one country's demand for the other country's goods in exchange for its own goods at different price ratios of exports and imports.

Reciprocal demand is expressed in terms of ‘offer curves' An ‘ offer curve' is graphical representation of reciprocal demand.  It indicates various quantities of exports offered by a country in exchange for various quantities of imports.

Illustration :

Draw Fig  14.3  Pg 164

OI = India's offer curve.

OR = Russia's offer curve.

Equilibrium = E ( intersection of OI and OR )

OB = India's domestic price ratio

OA = Russia's domestic price ratio

INDIA : offers ON of commodity ‘X'

Gets NE of commodity ‘Y'

RUSSIA : offers NE of commodity ‘y'

Gets ON of commodity ‘X'

At  home:

INDIA = Gets NL of commodity ‘Y'

In return for ON of commodity ‘X'

RUSSIA = gets ON of commodity ‘X' in return for NM of commodity ‘Y'

Result: Due to international trade :

INDIA's gain = LE of commodity ‘y'. ( gets more )

RUSSIA'S gain = EM of commodity ‘y' ( saves more)

• FACTORS DETERMINING GAINS FROM INTERNATIONAL TRADE :

Various factors determine gains from international trade .

They are :

Terms of trade :

Terms of trade determine the extent of gains from international trade. favourable terms of trade bring more gains.

A country gains more if the terms of trade are nearer to the internal exchange rate prevailing in the other country.

• Reciprocal demand :

The exact terms of trade will depend on the reciprocal demand a shift in the offer curve changes the extent of gains from trade.

Cost ratio :

Gains from trade also trade depend the cost of production traded goods.

A country gains from imports if a certain product can be imported at a lesser price than the cost of manufacturing it in it's home country.

• Level of income :

A country with high per capita income with no restrictions on income gains more.