STATIC AND DYNAMIC GAINS FROM TRADE:

Static Gains:
1. Maximization of Production:
According to the classical economists gains from trade result from the advantage
s of division of labour and specialization both at the national and internationa
l market. Given the resources and the technology of the country, it is specializ
ation based on comparitive advantage and trading that enables each country to ex
change its goods for the goods of another country. Thus it reaps greater gain th
an in the absence of international trade. Each country exports those goods which
it produces cheaper in exchange for the goods that other countries produce at a
lower cost. According to Riccardo, "The gains from trade consisted in the savin
g of costs resulting from the obtaining the imported goods through trade instead
of domestic production." Thus trade maximises production.
2. Increase in welfare:
As a result of international division of labour and specialization the productio
n of goods increases in the trading country. As a result the consumption of good
s increases and so does the welfare of the people. As per Riccardo, "The extenti
on of international trade very powerfully contributes to the increase in the mas
s of commodities and therefore, the sum of enjoyments."
3. Increase in National Income:
When a country gains from international specialization and exchange of goods in
trade, there is an increase in national income. This in turn leads to increase i
n the level of output and and growth of the economy.
4. Vent for Surplus:
The gain form trade also arises from the exchange of idle land, labour and other
resources in a country before it enters into international trade. With its open
ing to world markets, its resources are used to produce a surplus of goods which
would otherwise remain unused.
Dynamic Gains:
1. Efficient Employment of Resources:
The direct dynamic gain from International trade is that comparitive advantage l
eads to a more efficient employment of the productive resources of the world.
2. Widens the Market:
The major indirect gain from foreign trade is that it widens the size of the mar
ket. By enlarging the size of the market and scope of specialization Internation
al trade makes a greater use of machines, encourages inventions, innovations, ra
ises labour productivity, reduces costs and leads to faster growth.
3. Development of other activities:
When a country starts producing goods for exports and importing them for domesti
c consumption other economics activities also develop. There is development in i
nfrastructure, in power, building highways, bridges, fly-overs, etc. The primary
sector develops into the export of raw material and for domestic use. Tertiary
sector expands in the form of banks, communications, insurance, etc.

4. Increase in investments:
Foreign trade encourages the setting up of new units for assembling and producti
on of variety of goods. Supplementary and ancilliary units are established. Prod
uction for exports leads to backward and forward linkages in developing other ac
tivities refered to above. All these increase autonomous and induced investment
in the country.
TERMS OF TRADE :
The terms of trade refer to the rate at which the goods of one country exchange
for the goods of another country. It is the measure of the purchasing power of t
he exports of a country in terms of its inputs and is expressed as the relation
between export prices and import prices of its goods.
Jacob Viner and G.M. Meier have discussed many types of terns of trade, they are
as follows:
1. Commodity or Net Barter Terns of Trade:
The commodity or net barter terms of trade is the ratio between the price of a
countries export goods and import goods. Symbolically it can be expressed as Tc
= Px upon Pm where Tc stands for The commodity terms of trade
P for price Subscript x and m for export and import respectively.
To measure changes in commodity terns of trade over a period, the ratio of chang
e in export prices to import prices is taken. Then the formula becomes
Tc = Px1 upon Px0 the whole upon Pm1 upon Pm0
Where the subscript 0 and 1 indicate base and end periods
Taking 1971 as the base year and expressing both India's export prices and impor
t prices as 100 if we find that by the end of 1981 its index of export prices ha
d fallen 90 and import prices had risen to 110 then terms of trade had changed a
s follows
90 upon 100 the whole upon 110 upon 100 = 8.18.
It implies that India's terms of trade declined by about 18% in 1981 as compared
to 1971.
The concept of commodity terms of trade has been used by economists to measure t
he gain from international trade. The terms of trade as determined by the offer
curves in the Mill-Marshall analysis are related to the commodity terms of trade
.
Limitations:
1. Problem of Index Numbers
2. Change in quality of product
3. Problem of selection of period
4. Causes of change in prices
5. Neglect of import capacity
6. Ignores productive capacity
7. Not helpful in BoP disequilibrium
8. Ignores gains from trade
2. Gross Barter Terms of Trade:
The gross barter terms of trade is the ratio between the quantities of the count
ry's imports and exports.
Symbolically Tg = Qm upon Qx Where Tg stands for Gross terms of trade Qm for qu
aqntities of imports and Qx for quantities of export.
The higher the ratio between the quantities of import and export the better the
gross terns of trade. A larger quantity of imports can be had for a same volume

of export. To measure changes in gross barter terns of trade over a period, the
index number of the quantities of imports and exports of the base period and the
end period are related to each other.
Tg = Qm1 upon Qm0 the whole upon Qx1 upon Qx0.
Taking 1971 as the base year and taking both India's imports and exports as 100
if we find that the index of quantity imports had risen to 160 and that quantity
exports to 120 in 1981 then the gross barter terms had changed as follows
Tg = 160 upon 100 the whole upon 120 upon 100 = 13.3
It implies that there was an improvement in the gross barter terns of India by 3
3 % in 1981 as compared with 1971.
When the net barter terms of trade (Tc) equals the gross barter terms of trade (
Tg) the country has balance of trade equillibrium.
It shows that total reciepts from export goods = total payments of import goods.
Criticism :
1. Aggregating goods, services and capital transaction
2. Ignore factor productivity
3. Neglects BoP
4. Ignores improvement in production
5. Not true index of wellfare
DETERMINANTS OF TERMS OF TRADE:
1. Reciprocal demand and supply :
The Terms of Trade of a country depends upon reciprocal demand and supply, i.e.
the strength and elasticity of each country's demand and supply of exports and i
mports.
When the demand for exports of a country is less elastic as compared to its impo
rts its Terms of Trade will be favorable. As its exports will fetch a higher pri
ce than its imports. On the other hand, if the demands for its imports is less e
lastic than its exports its Terms of Trade will be unfavourable because it will
have to pay a higher price for its imports. If the supply of its exports is more
elastic than its imports then its Terms of Trade will be unfavourable because i
t can increase or decrease the supply of its exports in keeping with internation
al market conditions. The opposite will be the case when the supply of exports i
s less elastic so the Terms of Trade will be favourable.
2. Change in Demand :
The Terms of Trade are also influenced by the size of demand for exports and imp
orts of a country. Other factors remaining the same, if the demad for export inc
reases it will raise the price of exportables as against the prices of importabl
es. The Terms of Trade will be favourable. On the other hand if the demand for i
mportables increases their prices will rise as against the price of exportables
thus worsening the Terms of Trade.
3. Changes is factor endowments : With given tastes and technology if the increa
se in factor supply is related to export industries it will lead to the producti
on of more export goods and less of import goods.
As a result the Terms of Trade will worsen because export of more goods will bri
ng down their prices in the world markets conversely if the growth of factors pr
oduces more of import competing goods the Terms of Trade will improve. As the de
mand for import goods will fall which will bring down their relative prices in t
he world market.
4. Change in technology :
If the technological changes lead to the production of more export goods their s
upply will increase and prices will fall relating to its imports. It will export
more than its imports and hence its Terms of Trade will worsen. On the contrary

if it leads to the production of more import competing goods its volume of worl
d trade will be less and its Terms of Trade will increase.
5. Changes in Tastes :
Changes in tastes of the people of a country influence its Terms of Trade with a
nother country. If the taste for the product of another country increases it lea
ds to increase in the demand for the imported goods and thus Terms of Trade will
worsen and vice versa.
6. Economic Growth:
Another factor is economic growth which increases the country's productive capac
ity, well-fare and income, given tastes and technology. Economic growth affects
Terms of Trade in two ways :
The first is the demand effects which? increases the demand for imports as a res
ult of increase in per capita income with economic growth.
The second is the supply effect which increases the supply of exportables and im
port competing goods. It is the net effect of these two effects which ultimately
determine the Terms of Trade of a country. If the demand effect is more powerfu
l and the volume of trade increases through imports, its Terms of Trade will be
unfavourable. On the other hand, if the supply effect is more powerful and the c
ountries volum of trade increases through a rise in exports and import competing
goods its Terms of Trade will improve.
7. Tariffs:
An import tariff improves the Terms of Trade of the tariff imposing country, sin
ce tariff duties will reduce the quantity of imports as comoared to exports.
8. Quotas:
Fixation of quotas also reduces imports and thus improves Terms of Trade of the
country fixing quotas.
9. Devaluation:
By devaluation it is meant a reduction of the value of domestic currency in term
s of the foreign currencies. Devaluation makes imports costlier and exports chea
per in the foreign market thus it reduces imports and increases exports and make
s the Terms of Trade favourable for the devaluing country but the elasticities o
f demand and supply of exports and imports determine deterioration or improvemen
t in its terms of trade. If both the foreingn demand for exports and home demand
for imports are highly inelastic to price movements, devaluation leads to an im
provement in the terms of trade and vice versa.
10. Market Conditions:
A country which has got monopoly or oligopoly in the goods which it exports in t
he world market, but its import market is competitive, its Terms of Trade will b
e favourable for it will sell its goods at a high price in the market. If a few
countries are oligopolistic and form a cartel such as oil producing countries, t
hey can raise the price of oil by reducing its supply so the Terms of Trade will
improve.
11. Import Substitutes:
If the country produces import substitute goods in sufficient quantities, its im
port demands for such goods will be low. As a result it will import less and its
Terms of Trade will be favourable and vice versa.
12. International Capital Flows:
An inflow of capital from abroad in the form of capital and other goods rekuces
the demand for home products and exportables. As a result the prices of exportab
les fall related to importables, thereby worsening the Terms of Trade of the cou
ntry. On the other hand when there isf an outflow of capital to repay the dept i
n the form of larger exports, their prices will fall, which again makes the Term
s of Trade unfavourable for the country.
13. Balance of Payments:
Deficits in BOP brings improvement in Terms of Trade because the exchange rate f
alls. On the other hand, a surplus in BOP worsens the Terms of Trade by increasi
ng the exchange rate of the currency.
14. Inflation and Deflation:
Inflation worsens the Terms of Trade because of the rise in domestic prices. On
the other hand deflation improves the Terms of Trade because the prices of domes

tic goods fall, the demand for export increases and imports fall.