Page 24 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes To take an example; in country A, 2 units of labour produce 10 units of X and 10 units of Y, while in
country B the same labour produces 6X and 8Y. The domestic exchange ratio (or domestic terms of
trade) in country A is 1X = 1Y, and in country B, 1X = 1.33Y. This means that one unit of X can be
exchanged with one unit of Y in country A or 1.33 units of Y in country B. Thus, the termsof trade
between the two countries will lie between IX or 1Y or 1.33 Y.

Y
Commodity
O
R
T
A

B
E P

S

K
X-Commodity
Figure 2.3: Marshall-Edge worth offer Curves and Distribution of Gains from Trade

However, the actual exchange ratio will depend upon the reciprocal demand, i.e., “the relative strength
and elasticity of demand of the two trading countries for each other’s product in terms of their own
product.” If A’s demand for commodity Y is more intense (inelastic), then the terms of trade will be
nearer 1X = 1Y. The terms of trade will move in favour of B and against country A. B will gain more
and A less. On the other hand, if A’s demand for commodity Y is less intense (more elastic), then the
terms of trade will be nearer 1X = 1.33 Y. The terms of trade will move in favour of A and against B.
A will gain more, and B less.
The distribution of gains from trade is explained K in terms of the Marshall-Edgeworth offers curves
in Figure 2.3 OA is the offer curve of country A, and OB of country B. OP and OQ are the domestic
constant cost ratios of producing X and Y in country A and B respectively. These rays are, in fact, the
limits within which the terms of trade between the two countries lie. However, the actual terms of
trade are settled at E the point of intersection of OA and OB. The line OT represents the equilibrium
terms of trade at E.
The cost ratio within country A is KS units of Y and OK units of X. But it gets KE units of Y through
trade. SE units of Y is, therefore, its gain. The cost ratio within country B is KR units of Y and OK units
of X. But it imports OK units of X from country A in exchange for only KE units of Y. ER units of Y is
its gain. Thus, both countries ain by entering into trade.
Haberler’s Proof of the Gains of Trade

Haberler has specified the gains of trade in a given diagram. In Figure 2.4 AA is the production
possibility curve. Before trade H is the equilibrium point showing the state of production and
consumption. The slope of the tangent DD at H shows the price ratio before trade. After international
trade price ratio is shown by PP line which is tangent at point T on the PPC. Point T represents
production equilibrium point and H' represents competition equilibrium point. At H' country exports
H'L quantity of X and import I.T quantity of Y commodity.

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