What are Gains from Trade? 

“Gains from trade” refers to various benefits or gains that a country or trader makes by participating in international trade.

A country's ability to produce a particular commodity at lower costs than other countries is known as comparative advantage. A country's specialization in a particular commodity is determined by comparative advantage.

A country's ability to produce more quantity of a good with limited inputs per unit of time compared to another country that produces the same good is known as absolute advantage.

Trade has become inevitable for the liberalized economies of the world. Gains from international trade are beneficial in the long term for all countries globally. Today the world has become a global village. Countries around the world are participating in foreign trade with the motive of gains. Dynamic gains of trade have also contributed immensely by employing productive resources efficiently. These dynamic gains can be experienced by comparative advantages of trade. Liberalized economies of the world are lucid for productivity and foreign trade. The liberalized economies based on comparative advantages decide for foreign trade of goods and services. World Trade Organization (WTO) frames rules and regulations for transparent trade across the world. It ensures economic gains from trade for all economies. Trade costs are analysed by countries before policy planning. It will enable the country in calculating net profit from foreign trade. Along with this, the economist also considers economics that is concerned with the factors of production. It helps in knowing the actual cost of production of goods and services, eventually, comparative advantages could be ascertained.

As per economics, gains from trade are the net export that the country or trader makes by participating in the international trade business. Economics is a discipline that deals with various aspects of economies and suggests measures in the form of theories for robust trade which strengthens the economies. The economic cost involved in the production of goods helps the country to decide whether to participate in foreign trade. As it is one of the measures to check comparative advantages.

Uneven distribution of natural resources provides an opportunity for trade. Trade strengthens all production, utility services, and foreign currency. International business increases national income and also provides goods and services at competitive and reliable prices.

Trade Benefits Concerning Production and Consumption

The benefits or gains of trade between two countries could be analysed better if we know their production and consumption of goods. The production of goods depends on the availability of factors of production and technology. The country may be equipped enough to have robust production of say product 'x' but their consumption may be low. In this case, the surplus goods produced by the country can be traded. But in the case of non-participation, this opportunity of trading can be lost. It infers that trading boosts production and supplies of goods at a reliable rate. Also, it provides goods to those countries that demand them. Overall, it boosts the productivity of goods and services across the global world.

Theories of International Trade

Heckscher-Ohlin Theory 

It was devised by Swedish economists. It is also called the Factors Proportions theory. It is based on the factors of production i.e., land, labor, and capital. It states that the country could have immense benefits by investing in plants for processing raw material available in abundance. The goods that are readily available in a country can be processed and transported to other countries. It augments the foreign exchange of the nation. It also boosts economic activity within the country.

For example, India gets a shipment of mobile parts of Micromax from china. The mobile parts are designed and developed in China. In India, these parts are assembled and these mobile phones are produced and brought to the market for selling. These activities of producing and assembling mobile parts grow economic activity in both countries. Economic activity helps a country by augmenting its gross domestic product (GDP). It further helps by creating more employment opportunities.

Modern Firm Based Theory 

Classical theory could not address the issues of expansion of multinational companies. To resolve these issues, this modern firm-based concept was developed by business schools. It enabled multinational companies in their expansion, globally.

Under it, they explored the role of the firm to promote imports and exports. Additional factors like technology, product life-cycles, quality, and brand name were incorporated in creating strategies for trade. Countries are encouraged to trade like firms selling their products internationally. 

Mercantilism

Mercantilism is an economic concept that advocates government regulation of international trade to generate wealth and strengthen national power. Merchants and the government work together to reduce nationalism—funds corporate, military, and national growth.

Factors Determining Participation

• Price Differential 
• Cost Differentials 

Price Differential

It is all about the difference in the price of the product in the country which is importing it. It is certain that consumption of the imported products would be more if cheaper.

For example, in India, imported products from one of its neighboring country are consumed more as it is cheap. So, price differential plays a pivotal role in trading business across countries.

Cost Differential

It refers to the differences in the input price involved in the production of goods. Inputs in terms of revenue, involved in various factors of production are considered to evaluate the total production cost. Availability of natural resources and skilled labor, and the latest technology play a vital role in minimizing the inputs of production.

For example, General Motors had established its manufacturing plant in one of the Asian countries. Skilled and cheap labor is available in the countries of Asia and Africa. Production per unit of vehicle would be less because of cheap labor and availability of input materials.

Measures to Calculate Gains of Trade

Classical economists have suggested two methods to measures the gains from global trade. These are as follows.

1. Terms of Trade
2. Cost Differential

Terms of trade

It can be defined as the number of goods a country can import per unit of its export. It can be said that it is the relative price of export with respect to import. It is expressed in the form of the ratio of export price and import price.  Better terms of trade enable the country to purchase more units of imported goods per unit of its goods shipped. Also, fluctuation in the currency has an impact on the terms of trade. For example, an increase in the value of the currency of a country would enable a lesser value for its imports. The price of goods will not have any impact on the domestic market. But the monetary inputs in the production of goods would rise. In simple terms, an increase in the value of currency makes import cheaper and the export dearer.

Cost Differential

The cost differential is all about evaluating the monetary inputs involved in the production of goods in both the countries participating in trade. However, it would be difficult to evaluate the total monetary inputs involved in the production of goods in both countries.

Hence, it is better to evaluate the gains of trade through terms of trade as it is easier.

Trade Subsidies in the Context of WTO

It is expected from the country to participate in international trade for long-term gains and the benefits and prosperity of the entire world. Trade subsidy is legitimate if the objective is based on the welfare of all. It can be justified. However, countries are engaged in trade subsidies just to boost their export.

Trade and Cultural Context

Countries throughout the world differ with respect to their culture and civilization. International Business gets impacted due to these cultural issues. For example, India due to its cultural issues does not want dairy products shipment from the USA. Such policies are formulated under the trade agreements. Comparative advantages cannot be expected because of this aspect.

Trade with the Context of Globalization

Globalization has connected countries across the world in a single market. Free trade can boost the economies throughout the world. Countries across the globe are trying to maintain the balance of trade. Free trade generally promotes international business to great extent. But today countries have been promoting the ‘protectionist policy’, which hampers business globally with respect to trade. Dynamic gains enable efficiently

Absolute Advantage

 A country is supposed to have gained from trade if it has produced more units of goods per labor. This is referred to as an absolute advantage.

Comparative Advantages

 A country is said to have comparative advantages if it produces goods and services that have a lower opportunity cost. The goods and the services produced could be consumed within its boundary.

Factors Affecting International Trade

Following are the factors briefing how they affect international trade.

Free trade agreements: Free trade agreements among countries enables international trade to flourish.

Balance of Trade

Countries try to maintain the balance of trade for various reasons. It helps countries in maintaining foreign exchange.

Trade Barriers

These are the government restrictions with respect to trade across countries. It is detrimental to trade as it prohibits trade among countries. The trade without restrictions will enable economic gains. In short term, it seems beneficial but it hampers economics in long run.

Trade Flows

It is the measure to calculate the net value of trade between two countries. It can be achieved by subtracting total imports from the total export of the country for a particular year.

Tariff on Trade

It is also one of the important factors of trade. Countries charge a certain percentage of tax on export and imports of products.

Population and Size of Economy

More the population, the higher would be the demand for specific fast-moving consumer goods and other commodities.

Currency Fluctuation

Currency fluctuation also plays important role in international business. The imports become cheaper with the rise in the value of the domestic currency. However, the price of the goods would remain the same in the domestic market.

Demand and Supply of Goods

Demand for goods depends on the needs of the population and these goods can be supplied by the one which has surplus production or has some other gains from this trade.

Advantages of Trade 

Here are a few advantages of trading internationally:

Grows Revenue 

The more a country exports, the more revenue it gains. This revenue is added to the National income, which gives it more purchasing power and gives a boost to different sectors of the country.

Gains from Specialization

If a country has to sustain itself in the international market, it needs to find a specialized commodity. This specialized commodity will give an advantage to the exporting country over the competition.

Improves Labor Productivity

A country has to upgrade its labor productivity to stand a chance against its competition in the international market. This upgraded productivity is beneficial for the domestic market as well.

Contribution to GDP

The boost in labor productivity and up-gradation of other factors of production increases productivity and this also improves the overall GDP of the country.

Context and Application

The subject “Gains from Trade” is important for the professionals associated with international business exclusively in trading. The topic is significant for students enrolled in

• MBA (International Business
• Master in Commerce and Economics
• Bachelors in Commerce and Economics
• Bachelors in Business Administration

The topic "Gains from Trade" would help fellows planning to have research work on foreign trade, principles that govern trade policy of nations. Gains from trade can help traders and merchants planning to set up their own international trade unit. People working with the Government's Commerce and Trade ministries can gain from this topic.

Related Concepts

• Trade policy
• Tariffs and Quotas
• International Economics
• Production Possibility Frontier (PPF)

Practice Problem

Problem: What is free trade?

Solution: When there are no tariff barriers and other non-tariff barriers to trade, a country can freely export and import, this phenomenon is called free trade. In a country with free trade, consumers pay less, imports and exports grow, economies of scale are utilized and the general consumer has a wider range of products to choose from.