Page 19 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 2 : Measurement of Gains from Trade

appeal for our setting. The first property is “maximality” : for each economy, no reference allocation Notes
leads to a larger vector of gains from trade than the vector selected by the metric. The second property
is “monotonicity” with respect to set inclusion : a metric selects a larger vector of gains from trade in
an economy with a larger set of possible gains from trade. The third property is “homogeneity” : a
homogeneous expansion of the set of possible gains from trade leads to a homogeneous expansion of
the vector selected by the metric.
2.1 Gains from Trade

The combination of consumer surplus and producer surplus obtained by buyers and sellers when
engaging in a market exchange. Gains from trade arise because buyers are typically willing and able
to pay a higher price to purchase a good than what they end up paying and because sellers are
typically willing and able to accept a lower price to sell a good than what they end up receiving. Both
sides of the market exchange are thus better off, have a net gain in welfare, by making the trade.
While all types of market exchanges generate gains from trade, this topic is perhaps most important
for an understanding of international trade.

Buyers and sellers engage in market exchanges because they benefit from the trade.

As a generally rule both sides are better off after the exchange than they were before the exchange.
Buyers are better off because they have a net gain in consumer surplus. Sellers are better off because
they have a net gain in producer surplus.
Voluntary market exchanges are undertaken because they are beneficial to both sides of the transaction.
If buyers and sellers did not gain from the trade, then they would not voluntarily undertake the
trade.
While the gains obtained from market exchanges provides insight into all forms of trading and the
very existence of a market-based economy used to allocate resources, it also provides a great deal of
insight into trading among nations, that is, international trade. When two nations engage in trade
they do so because they gain from the trade. Both countries are better off after the trade than they
were before.
Market Trades
The motivation behind international trade is essentially the same as for any market exchange. People
buy and sell goods because they expect to be better off after the exchange than they were before. To
illustrate this, consider the motivation of two hypothetical people -- Horst Duncanstein and Francine
von Sutter -- who are primed to do a little exchanging.
• From the Buying Side: First, consider the situation facing Horst Duncanstein, who is
exceptionally fond of turnip lasagna. Eating turnip lasagna makes Horst a happy fellow. It
improves his level of well being. It satisfies his wants and needs.
To this end, Horst is willing to pay a price for the turnips needed to make his turnip lasagna.
Horst has a maximum price that he is willing to pay for the needed turnips -- a demand price.
If the price is too high, then he will not purchase turnips, opting to consume another good,
perhaps carrots to be used in a carrot casserole. However, should the price he pays for his
turnips be less than his demand price, then he comes out ahead. He pays less than the value he
receives, what is termed consumer surplus. He gains from this trade.
• From the Selling Side: Second, consider the situation facing Francine von Sutter, a turnip farmer.
While Francine does not have a particular fondness for turnips, she does enjoy the farming
business. She has the land, labor, and capital needed to produce turnips.
To this end, Francine is willing to provide turnips to willing buyers so long as she can cover the cost
of production. Francine has a minimum price that she is willing to accept to produce turnips -- a
supply price. If the price is too low, then she will not produce turnips, opting to produce another

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