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International Trade and Finance

Notes procedure which is fair at each step, and obtains an efficient allocation at the limit. Also, we provide
an algorithm to reach it.
2.3 Measurements of Gain from International Trade

The gains from international trade are measurable. Prof. Jacob Viner says that the classical economists
had adopted three methods of measuring the gains from internatilnal trade.
1. Measurement of increased real income by comparative cost theory.
2. Increase in the level of national income.
3. Improvement in terms of trade.
However, with the introduction of J.S. Mill’s theory of Reciprocal Demand, the most frequently used
method of measuring gains from trade is the terms of trade method.
Hence, in order to measure gains from trade, three approaches are used.
1. Ricardo’s Approach
2. J.S. Mills Ajpproach
3. Modern Approach or Samuelson’s Approach
Ricardo’s Approach

According to Ricardo, a country would export those goods in which its comparative cost of production
is less. This is proved in an example and diagram.

India: 15 units of cotton or 20 units of wheat
(i)
Pakistan: 10 units of cotton or 10 units of wheat

If in every country only two units of the factor are used, the product would be as under:

India: 15 units of cotton + 20 units of wheat
(ii)
Pakistan: 10 units of cotton + 10 units of wheat

1. Without specialization, if both the countries produce both the commodities, the total production
in the two countries would be as under:

India + Pakistan = 25 units of cotton + 30 units of wheat
(iii)
(25C + 30W)

2. If there is specialization on the basis of comparative cost theory, in India specializing in the
production of cotton, total production would be:

India = 25 units of wheat
(iv)
Pakistan = 20 units of cotton

India + Pakistan = 40 units of wheat + 20 units of cotton
Comparing situations (ii) and (iii), reveals that due to specialization in the two countries, production
of wheat increases by 10 units whereas there is loss of 5 units of cotton.

Net Result = + 10 units W – 5 units C (v)

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