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International Trade and Finance

Notes units of rubber and imports 25 units of textiles. This means, Malaysia’s consumption share of
rubber and textiles is 50 + 25 and India’s consumption share of the two goods would be 50 + 75,
as you can see in Table 4 above. Compare the situation in Table 4 with the situation in Table 1
and you will notice that Malaysia’s consumption of rubber and textiles, before or after trade,
has remained the same. This is in spite of production gain of 25 units in Malaysia. India’s
consumption share, however, after trade has gone up to 50 + 75 as compared to 25 + 50 before
trade, i.e. India’s consumption gain has been equal to 50 (i.e. 50 + 75 after trade minus 25 + 50
before trade). The entire world production gain has been 50 (i.e. 200 after trade minus 150 before
trade), and all of that world production gain has gone entirely to India. Malaysia’s consumption
gain has been zero.
This means that the terms of trade (viz. 2:1 terms) have been in favour of India alone. They are
extremely unfavourable to Malaysia. How ? Note here, that the terms of trade at 2:1 are exactly
equal to the internal cost ratio in Malaysia (i.e. 2:1). What it means is that, for Malaysia, the cost
of importing one unit of textiles (which is 2 units of rubber) is exactly the same as the cost of
producing one unit of textiles domestically (which is 2 units of rubber). Therefore the rule
governing the consumption gain from trade is as follows : If the international terms of trade are
equal (or closer) to the internal cost ratio of any country, then that country will not gain at all (or
gain less) from international trade regardless of whether that country has achieved production
gains from trade. Let us now take another situation. The reverse of what we have taken here,
and show the results.
(c) Let us now assume that the international terms of trade are 1:2 (i.e. one unit of rubber sells for
2 units of textiles in the international market), and these terms of trade are equal to the internal
cost ratio in India (viz. 1:2). In this situation all the consumption gains must go to the other
country—Malaysia, reducing India’s consumption gain to zero. Consumers in India would,
then, consume the same combination of rubber and textiles after trade as they did before trade.
This is despite India’s achieving production gains of 25 after international trade as shown in
Table 5 below :
Table 5 : Consumption Shares after International Trade
Commodities Total
Countries Rubber Textiles Consumption
(units) (units) (units)

Malaysia 75 50 125
India 25 50 75

World 100 100 200

After trade, India produces 100 units of textiles—a production gain of 25. It retains 50 units for
its own consumption and exports the remaining 50 units of textiles to Malaysia. At the present
international terms of trade of 1:2, India will receive 25 units of rubber imports for an export of
50 units of textiles to Malaysia. This means that after trade, India’s consumption shares are
25 + 50 of rubber and textiles, and Malaysia’s shares are 75 + 50 of the two goods. Compare
these figures (in Table 5) with those of pre-trade (in Table 1) and you will notice that India’s
consumption gain has been zero; all the consumption gains have gone to Malaysia. This is
because of the terms of trade (which are 1:2) being exactly equal to the internal cost ratios in
India. That means, for India, the cost of importing the good has been the same as the cost of
producing that good domestically.
Thus, the gains from trade depend upon the terms of trade. As the terms of trade approach nearer to
the domestic cost ratios (or internal terms of trade), the country concerned will start experiencing
adverse trading conditions internationally and begins to gain less and less from international trade.
Internal cost ratios in the two countries, in a model of world trade where there are only two countries,
fix the upper and the lower limits to the international terms of trade. As long as the terms of trade lie

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