Factors Determining Gain Size
Following are the important factors determining the size of gain and its proportion:
1. Nature of terms of trade
Terms of trade, i.e. the rate at which one country’s goods exchange against those of another, tend to affect the size of gain from trade. Terms of trade may be fovourable or unfavorable to a country. A favourable term of trade implies a relatively larger share of gain to a country and an unfavorable term of trade would mean a relatively smaller share of gain accruing to the country. Between the two countries, if one has a favorable term of trade, the other must necessarily have an unfavorable term of trade. According to Riparian example, if terms of trade are: 1 unit of wine = 1.1 units of cloth, it is favourable to Portugal but unfavorable to England.
The terms of trade are favourable when they are set closer to the domestic exchange ratio of the opposite country and unfavorable if they are closer to the domestic exchange rate of the country under consideration.
Classical economists, however, affirm that whether the terms of trade are favourable or unfavorable, all the participating nations gain because under free trade based upon comparative costs advantage, each country is able to import products at lower than their domestic costs.
2. Difference in cost ratios
According to Harrod, the gain from international trade depends on the relation between the ratios of the costs of production in the two countries concerned. The gain does not depend on the comparative cheapness of producing commodity X or Y in the two countries. It depends on the relation between the ratio of the cost of producing of x to that of Y in one country and the ratio of the cost of producing of X to Y in the other country. Gain is possible if the cost ratios are different in different countries.
Briefly, the gain from international trade arises because of the difference in cost ratios in the production of two commodities in different countries. Say, for example, if in England certain amount of labour produces 10 units of cloth and 5 units of wine, while in Portugal the same quantity of labour produces 5 unit of cloth and 15 units of wine, the labour cost ratio in England is 1:2 and in Portugal 3:1 for producing these two commodities. Now, when England specialises in the producing of cloth and Portugal of wine and trade takes place between these two countries, they both would gain because they will get either cloth or wine cheaply suppose the terms of trade are 1 unit of wine equal to 1 unit of cloth. Portugal by trading with England gets 1 unit of cloth in exchange for 1 unit of wine. Thus two third units of cloth more is the gain to Portugal due to international trade similarly England, by trading with Portugal gets 1 unit of wine in exchange for unit fo cloth in domestic trade, however, it gets only ½ unit of wine against 1 unit of cloth. Obviously, ½ units more of wine is England’s gain in international trade.
3. Productive Efficiency of the country
The gain from international trade also depends upon the relative productive efficiency of the country. If the productive efficiency of the home country increases, it will be to the advantage of the foreign country (and vice versa), for it will lead to more favourable terms of trade for the latter.
4. Relative Elasticity of Demand
The gain from international trade also depends upon the relative elasticity of demand for the commodities in different countries and the relative elasticity of supply of different commodities in different countries. When exchange takes place, as a result of specialization, the amount of the commodity that will be imported by a country depends not only on the difference in cost ratios but also on how the demand for the commodity changes.
5. Factor endowments and technological conditions
There exists a positive correlation between the size of foreign trade and the total gain reaped by the participating notations. However, kinds and quality of factors available to a country and its technological advancement has unique significance in this regard. A big capital abundant and technically as well as economically advanced country will have a larger size of foreign trade then a small labour abundant technically and economically backward country. Moreover, a country exporting manufactures will have favourable terms of trade against a country exporting primary products.
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