Page 33 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 3 : Free Trade Theory — Absolute Advantage, Comparative Advantage and Opportunity Cost

Supposing now, that the consumers in both the countries want to consume some mix of both Notes
the goods; then Malaysia could export, say, 40 units of rubber in exchange for 40 units of textile
imports from India (at 1:1 terms of trade). The resulting situation will be like what it is in
Table 3 as given follows :
Table 3 : Consumption Shares After International Trade
Commodities Total
Countries Rubber Textiles Consumption
(units) (units) (units)

Malaysia 60 40 100
India 40 60 100

World 100 100 200

Malaysia, after trade, has produced 100 units of rubber (See Table 2). Consumers in Malaysia
wish to consume 60 units of rubber, which means that this country can export 40 units of rubber
to India. At international terms of trade of 1:1, Malaysia exports 40 units of rubber in exchange
for 40 units of textile imports from India. After trade, the consumers in Malaysia are able to
consume a combination of rubber and textiles of 60 and 40 (See Table 3). Compare these
consumption levels with those of pre-trade in Table I here it was 50 units of rubber and 25 units
of textiles. Clearly, consumers have gained in terms of both rubber and textile consumption
after trade, as compared to before trade.
Similarly for the other country, India imports 40 units of rubber and exports 40 units of textiles
at the same terms of trade. India’s post-trade consumption of rubber and textiles is 40 and 60
(See Table 3) whereas it was 25 and 50 before trade (See Table 1). Therefore, as a result of trade,
consumers in this country have also gained.
Note that the consumers in both the countries have gained—and they have gained in equal
terms; e.g., Malaysia’ consumption gain is 25, which is exactly equal to India’s consumption
gain also of 25 (compare post-trade consumptions of rubber and textiles in the two countries, in
Table 3 with their pre-trade consumptions of the two goods in Table 1). This equal share in
consumption gains between India and Malaysia has been made possible by 1:1 terms of trade.
The gains from trade (in terms of consumption) depend upon the terms of trade. In this particular
case, the 1:1 terms of international trade fall exactly between the two opportunity cost ratios (or
internal cost ratios) in the two countries. This is the reason why the two countries’ share of
consumption gains is absolutely equal.
(b) Let us now assume that the international terms of trade are 2:1 (i.e. two units of rubber are
exchanged for one unit of textiles in the international market). This would result in a situation
of consumption gains such as the one represented in the following Table :
Table 4 : Consumption Shares After International Trade

Commodities Total
Countries Rubber Textiles Consumption
(units) (units) (units)

Malaysia 50 25 75
India 50 75 125

World 100 100 200
After trade, Malaysia produces 100 units of rubber; it retains 50 units of it for its own consumption
and exports the other 50 units to India. At the new terms of trade of 2:1, Malaysia exports 50

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