gains from trade
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gains from tradethe extra production and consumption benefits that countries can achieve through INTERNATIONAL TRADE. Countries trade with one another basically for the same reasons as individuals, firms and regions engaged in the exchange of goods and services - to obtain the benefits of SPECIALIZATION. By exchanging some of its own products for those of other nations, a country can enjoy a much wider range of commodities and obtain them more cheaply than would otherwise be the case. International division of labour, with each country specializing in the production of only some of the commodities that it is capable of producing, enables total world output to be increased and raises countries’ real standards of living.
A country's choice of which commodities to specialize in will be determined in large measure by the advantages it possesses over others in the production of these things. Such advantages can arise because the country can produce particular commodities more efficiently, at lower cost, than can others. The static, or ‘pure’, theory of international trade emphasizes that opportunities for mutually beneficial trade occur as the result of differences in comparative costs or COMPARATIVE ADVANTAGE. Countries will gain from trade if each country EXPORTS those commodities in which its costs of production are comparatively lower and IMPORTS commodities in which its costs are comparatively higher.
This proposition is demonstrated in Fig. 79 (a) for a simple two-country (A and B) and two-product (X and Y) world economy. The same given resource input in both countries enables them to produce either the quantity of X or the quantity of Y. In the absence of trade between the two, X and Y exchange in country A is in the ratio IX/IY, and, in country B, in the ratio IX/3Y These exchange ratios indicate the marginal OPPORTUNITY COST of one commodity in terms of the other. Thus, in country A the opportunity cost of producing one more unit of X is IY
It can be seen that country B is absolutely more efficient than country A in the production ofY and just as efficient in the production of X. However, it is comparative advantage, not ABSOLUTE ADVANTAGE, that determines whether trade is advantageous or not. Country B's comparative advantage is greater in the production of commodity Y, of which it can produce three times as much as country A. Alternatively, we can say that country B's relative efficiency is greater in producing commodity Y because the resource or opportunity cost of producing an additional unit of Y is one-third of one unit of X in country B but IX in country A. Country A, by concentrating on the commodity it can produce with least relative inefficiency, has a comparative advantage in the production of X; i.e. the resource or opportunity cost of producing an additional unit of X in country A is only 1Y, while in country B it is 3Y. Thus, in terms of real factor costs, commodity X can be produced more cheaply in country A, and commodity Y can be produced more cheaply in country B.
This combination of comparative advantages opens up the possibility of mutually beneficial trade. Domestically in country A, 1X can be exchanged for 1Y, but abroad it can be exchanged for anything up to 3 Y Trade will be advantageous to it if it can obtain more than 1Y for 1X. Domestically, in country B, 1Y can be exchanged for one-third of 1X, but abroad it can be exchanged for anything up to 1X. It will be to B's advantage if it can obtain, through trade, more than one-third of X for 1Y .
The limits to mutually beneficial trade are set by the opportunity-cost ratios. Within these limits, specialization and trade on the basis of comparative advantage will enable both countries to attain higher consumption levels. This possibility is indicated in Fig. 79 (b), assuming the exchange ratio to be 1X = 2Y Using its entire resources, country B can produce 600Y, of which it consumes, say 400 and exports 200. Country A can produce 200X, of which it consumes 100 and exports 100. With trade, the 200Y can be exchanged for 100X, enabling country B to consume 400Y and 100X, and country A to consume 200Y and 100X. Without trade, country B can transform (at an internal exchange ratio of 1X/3Y) 200Y into only 662/3X, while country A can transform (at an internal exchange ratio of 1X/1Y) 100X into only 100Y. Thus both countries gain by specialization and trade. How the gain is shared between countries A and B depends essentially upon the strength of demand in the two countries for the goods they import. If country A's demand for commodity Y increases, the trading ratio of IX to 2Y would be likely to move against country A. Thus it might require 21/2Y exports to obtain IX imports, pushing country B nearer to the limit to mutually beneficial trade.
Obviously, in a more complex multicountry, multiproduct ‘real’ world situation it is less easy to be categorical about who gains from international trade and by how much. Some countries may possess a comparative advantage in a large number of products; others may possess few such advantages - countries differ in the quantity and quality of their factor endowments and are at different stages of ECONOMIC DEVELOPMENT. DEVELOPING COUNTRIES, in particular, may find themselves at a disadvantage in international trade, especially those that are over-reliant on a narrow range of volatile commodity exports.