Gains from trade

Gains from trade

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Gains from trade in economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

 refers to net benefits to agents
Agent (economics)
In economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....

  from allowing an increase in voluntary trading
Trade is the transfer of ownership of goods and services from one person or entity to another. Trade is sometimes loosely called commerce or financial transaction or barter. A network that allows trade is called a market. The original form of trade was barter, the direct exchange of goods and...

 with each other. In technical terms, it is the increase of consumer surplus plus producer surplus from lower tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....

s or otherwise liberalizing trade. It is commonly described as resulting from:
  • specialization in production from division of labor, economies of scale
    Economies of scale
    Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...

    , scope
    Economies of scope
    Economies of scope are conceptually similar to economies of scale. Whereas 'economies of scale' for a firm primarily refers to reductions in average cost associated with increasing the scale of production for a single product type, 'economies of scope' refers to lowering average cost for a firm in...

    , and agglomeration
    Economies of agglomeration
    The term economies of agglomeration is used in urban economics to describe the benefits that firms obtain when locating near each other . This concept relates to the idea of economies of scale and network effects...

     and relative availability of factor resources
    Factors of production
    In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

     in types of output by farms, businesses, location and economies
    An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...

  • a resulting increase in total output possibilities
  • trade through markets from sale of one type of output for other, more highly valued goods.

Market incentives, such as reflected in price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...

s of outputs and inputs, are theorized to attract factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

, including labor, into activities according to comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...

, that is, for which they each have a low opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

. The factor owners then use their increased income from such specialization to buy more-valued goods of which they would otherwise be high-cost producers, hence their gains from trade. The concept may be applied to an entire economy for the alternatives of autarky
Autarky is the quality of being self-sufficient. Usually the term is applied to political states or their economic policies. Autarky exists whenever an entity can survive or continue its activities without external assistance. Autarky is not necessarily economic. For example, a military autarky...

 (no trade) or trade. A measure of total gains from trade is the sum of consumer surplus and producer profits
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...

 or, more roughly, the increased output from specialization in production with resulting trade. Gains from trade may also refer to net benefits to a country from lowering barriers to trade such as tariffs on imports.

From publication of Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

's The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

 in 1776, it has been widely argued, that, with competition and absent market distortions
Distortions (economics)
A distortion is a condition that creates economic inefficiency, thus interfering with economic agents maximizing "social welfare" when they maximize their own welfare....

, such gains are positive in moving toward free trade
Free trade
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...

 and away from autarky or prohibitively high import tariffs. Rigorous early statements of the conditions under which this proposition holds are found in Samuelson in 1939 and 1962. For the analytically tractable general case of Arrow-Debreu good
Arrow-Debreu model
In mathematical economics, the Arrow–Debreu model suggests that under certain economic assumptions there must be a set of prices such that aggregate supplies will equal aggregate demands for every commodity in the economy.The model is central to the theory of...

s, formal proofs came in 1972 for determining the condition of no losers in moving from autarky toward free trade. It does not follow that no tariffs are the best an economy could do. Rather, a large economy might be able to set taxes and subsidies to its benefit at the expense of other economies. Later results of Kemp and others showed that in an Arrow-Debreu world with a system of lump-sum compensatory mechanisms, corresponding to a customs union
Customs union
A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff. The participant countries set up common external trade policy, but in some cases they use different import quotas...

 for a given subset set of countries (described by free trade among a group of economies and a common set of tariffs), there is a common set of world tariffs such that no country would be worse off than in the smaller customs union. The suggestion is that if a customs union has advantages for an economy, there is a worldwide customs union that is at least as good for each country in the world.

Benefits of gains from trade

Any trade, domestic or international, facilitates the division of labour and specialization which let countries accrue gains from international trade by participating in it. Trade is benefited to the importers as well as the exporters. Some of the benefits are as follows

1. Utilization of resources: Each country needs to produce some basic goods and services for their development. But by division of labour and specialization a country can produce the best suited goods as each country has some specific factors of production accordingly in which they specailize. this also leads to optimum utilization of resources and will also reduce cost as production will be on large scale and therefore the price.

2. Market expansion: When a country participates in trade international market is available, which brings large scale production, competition for the domestic market, best quality of the product, foreign investment etc. All these elements boost the development of the economy as its acce;ertes the growth process.

3. Advantageous to the consumer: International trade lower priced high quality goods in the domestic market which gives variety of goods to the consumer to choose best for them. Another advantage is they get foreign specialized good of one country in their domestic market as well as their specialized good is available in other country's market which gives them appreciation in terms of money as well as efforts.

4. No Scarcity: Every country faces problem of scarcity of resources of factors of production. This can be solved through international trade as the country can import those goods which it cannot produce. This brings out equal distributions of the resources.

5. Increase in world production level: If a country participates in international trade, than it will try to specalize its production to reduce the cost and earn gains from the international market. This will make them utilize their resources optimally. And when all the countries participating in international trade follow the same principle they contribute to the increase in world production level.

Measurement of gains from trade

Classical Economist there are two methods to measure the gains from trade;- 1) international trade increases national income which helps us to get low priced imports. 2) gains are measured in terms of trade. To measure the gains from the trade comparison of cost of production between domestic and foreign countries is required. But it is very difficult to acquire the knowledge of cost of production and cost of imports in domestic country. Therefore terms of trade method is preferable to measure the gains from trade.

Factors affecting gains from trade

There are several factors which determine the gains from international trade:

1.Differences in cost ratio: The gains from international trade depends upon the cost ratios of differences in comparative cost ratios in the two trading countries.If the difference between exchange rate and cost of production is lesser than lesser will be the gains from trade and vice-verse.

2. Demand and supply: If a country has elastic demand and supply it gives more gains from trade vice-verse with inelastic demand and supply.

3. Factor availability: International trade is based on the specialization and a country specializes depending upon the availability of factors of production. It will increase the domestic cost ratios and so the gains from trade.

4. Size of country: If a country is small in size its easy for them to specialize in the production one commodity and export the surplus production to a large sized country and can get more gains from international trade. Whereas if a country is large in size then they have to specialize in more than one good because the excess production of only one commodity can not be exported fully to a small sized country as the demand for good will reduce very frequently. so smaller the size of the country larger is the gain from trade.

5. Terms of Trade: Gains from trade will depend upon the terms of trade. If the cost ratio & terms of trade are closer to each other more will be the gains from trade of the participating countries.

6. Productive Efficiency: An increase in the productive efficiency of a country of a country also determines its gains from trade as it lowers the cost of production and price of the a result the country importing gains by importing cheap goods.

Static and dynamic gains from trade

The gains from trade can be classified into static and dynamic gains from trades. Static Gains means the increase in social welfare as a result of maximized national output due to optimum utilization of country's factor endowments or resources. Dynamic gains from trade, are those benefits which accelerates economic growth of the participating countries.

Static gain's are the result of the operation of the theory of comparative cost in the field of foreign trade. On this principle countries make the optimum use of their available resources so that their national output is greater which also raises the level of social welfare in the country. When there is an introduction of foreign trade in the economy the result is called the static gains from trade.

Dynamic gains from trade relate to economic development of the economy. Specialization of the country for the production of best suited commodities which result in a large volume of quality production which promotes growth. Thus the extension of domestic market to foreign market will accelerate economic growth.

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