Gains from trade in economics refers to net benefits to agents from allowing an increase in voluntary trading with each other. In technical terms, it is the increase of consumer surplus[1] plus producer surplus[2] from lower tariffs[3] or otherwise liberalizing trade.[4] It is commonly described as resulting from:
Market incentives, such as reflected in prices of outputs and inputs, are theorized to attract factors of production, including labor, into activities according to comparative advantage, that is, for which they each have a low opportunity cost. The factor owners then use their increased income from such specialization to buy more-valued goods of which they would otherwise be high-cost producers, hence their gains from trade. The concept may be applied to an entire economy for the alternatives of autarky (no trade) or trade. A measure of total gains from trade is the sum of consumer surplus and producer profits or, more roughly, the increased output from specialization in production with resulting trade.[8] Gains from trade may also refer to net benefits to a country from lowering barriers to trade such as tariffs on imports.[9]
From publication of Adam Smith's The Wealth of Nations in 1776, it has been widely argued, that, with competition and absent market distortions, such gains are positive in moving toward free trade and away from autarky or prohibitively high import tariffs. Rigorous early statements of the conditions under which this proposition holds are found in Samuelson in 1939 and 1962.[10] For the analytically tractable general case of Arrow-Debreu goods, formal proofs came in 1972 for determining the condition of no losers in moving from autarky toward free trade.[11] It does not follow that no tariffs are the best an economy could do. Rather, a large economy might be able to set taxes and subsidies to its benefit at the expense of other economies. Later results of Kemp and others showed that in an Arrow-Debreu world with a system of lump-sum compensatory mechanisms, corresponding to a customs union for a given subset set of countries (described by free trade among a group of economies and a common set of tariffs), there is a common set of world' tariffs such that no country would be worse off than in the smaller customs union. The suggestion is that if a customs union has advantages for an economy, there is a worldwide customs union that is at least as good for each country in the world.[12]
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Classical Economist there are two methods to measure the gains from trade;- 1) international trade increases national income which helps us to get low priced imports. 2) gains are measured in terms of trade. To measure the gains from the trade comparison of cost of production between domestic and foreign countries is required. But it is very difficult to acquire the knowledge of cost of production and cost of imports in domestic country. Therefore terms of trade method is preferable to measure the gains from trade.
There are several factors which determine the gains from international trade:
1.Differences in cost ratio: The gains from international trade depends upon the cost ratios of differences in comparative cost ratios in the two trading countries.If the difference between exchange rate and cost of production is lesser than lesser will be the gains from trade and vice-verse.
2. Demand and supply: If a country has elastic demand and supply it gives more gains from trade vice-verse with inelastic demand and supply.
3. Factor availability: International trade is based on the specialization and a country specializes depending upon the availability of factors of production. It will increase the domestic cost ratios and so the gains from trade.
4. Size of country: If a country is small in size its easy for them to specialize in the production one commodity and export the surplus production to a large sized country and can get more gains from international trade. Whereas if a country is large in size then they have to specialize in more than one good because the excess production of only one commodity can not be exported fully to a small sized country as the demand for good will reduce very frequently. so smaller the size of the country larger is the gain from trade.
5. Terms of Trade: Gains from trade will depend upon the terms of trade. If the cost ratio & terms of trade are closer to each other more will be the gains from trade of the participating countries.
6. Productive Efficiency: An increase in the productive efficiency of a country of a country also determines its gains from trade as it lowers the cost of production and price of the goods.as a result the country importing gains by importing cheap goods.
The gains from trade can be classified into static and dynamic gains from trades. Static Gains means the increase in social welfare as a result of maximized national output due to optimum utilization of country's factor endowments or resources. Dynamic gains from trade, are those benefits which accelerates economic growth of the participating countries.
Static gain's are the result of the operation of the theory of comparative cost in the field of foreign trade. On this principle countries make the optimum use of their available resources so that their national output is greater which also raises the level of social welfare in the country. When there is an introduction of foreign trade in the economy the result is called the static gains from trade.
Dynamic gains from trade relate to economic development of the economy. Specialization of the country for the production of best suited commodities which result in a large volume of quality production which promotes growth. Thus the extension of domestic market to foreign market will accelerate economic growth.