Page 32 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes Table 2 : Production Levels After International Trade

Commodities Total Output
Countries Rubber Textiles or GNP
(units) (units) (units)

Malaysia 100 0 100
India 0 100 100

World 100 100 200
After the trade establishment, Malaysia produces only rubber and no textiles. By using all the “x”
factors of production, Malaysia now produces 100 units of rubber. This is also the level of new GNP
in Malaysia after trade. Compare it with Malaysia pre-trade GNP of 75; the GNP increase has been by
25 units in real terms. In the same way, India would specialize in textile production; by using all “x”
factors of production to produce only textiles, India will be able to produce 100 units of textiles.
India’s new GNP level is equal to 100 units (of textiles production). Before trade, India’s level of GNP
was 75 units, which means that India’s GNP also rose by 25 units, thanks to international trade.
As a result of trade, you will notice, the GNP in the two countries went up; this means that both
countries became richer after trade as compared to before trade. The world GNP also increased from
a pre-trade level of 150 to a post-trade level of 200. There has been complete specialization in production
after trade. Both countries have become better off in terms of production (GNP) without making any
country worse off. This is for production gains from international trade; and the two countries have
been richer.
The two countries are of equal size in terms of GNP or the production capacities. These, then, are the
levels of GNP and economic welfare in the two countries in the absence of any trade between them,
i.e. when they are both “closed” economies.

Malaysia produces and consumes 50 units of rubber plus 25 units of textiles (i.e. a total
real GNP of 75). India produces and consumes 25 units of rubber plus 50 units of textiles
(i.e. a total real GNP of 75).

What about consumption gains of trade ? After trade, have the consumers in the two countries been
happier as a result of their countries becoming richer and more specialized in terms of production?
This depends on how the gains from production are distributed between the two countries. In other
words, the consumption gains to the two countries depend upon the terms of trade i.e. how many
units of rubber exchange for one unit of textiles between India and Malaysia.
(a) Suppose the terms of trade are fixed at 1:1, i.e. Malaysia and India agree to exchange 1 unit of
rubber for 1 unit of textiles. Then, depending upon the taste pattern in the two countries and
upon how much or how little they want to trade each other’s goods, the consumption gains can
be determined. If the two countries want to consume all that they have produced, it means that
their consumers have no taste for the product of the other country. Then there will be no trade
between them. Nonetheless the two countries will have had production gains (but note, however,
that such a condition of production specialization could have been created even without
international trade). We describe this situation as one where the consumers have an extreme
bias towards the product of their own country, and such situations are unlikely to exist.

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