What are the Sources of Gains from Trade?

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International trade based on differences in comparative advantage increases the efficiency with which world resources are used and thus, increases the world’s real income. But this is not the only gain to be had from international trade. If we allow for market imperfections and for dynamic considerations, trade may yield other gains.

We may now look at some of them:

Economies of Scale:

In the long run firms after experience economies of scale. This means that, as they produce more output, they can utilise inputs more efficiently and thus, decrease their average costs of production. In industries in which economies of scale are large and extend over a broad range of output, firms operating in a small national market perhaps cannot achieve the high output levels necessary to minimise production costs unless they can export some of their output.

In such situations, international trade offers an additional gain:

International trade increases the efficiency with which resources are utilised by permitting some firms to take advantage of economies of scale that they could not have enjoyed in the absence of trade.

This gain from trade is not very big for a country like the U.S., which has a large domestic market, but for countries like the Netherlands and Norway, which have small domestic markets, it can be significant.

Great Domestic Competition:

Whenever the number of producers in a domestic market is small, then these producers engage in a monopolistic restriction of output. That is, in their quest for maximum profits, they produce too little output for resource allocation to be efficient. One obvious cure is to increase the number of firms selling in the domestic market, and one way to do so is to open up this market to foreign sellers.

Thus, interna­tional trade may offer a third source of gain:

International trade may increase the efficiency with which domestic resources are allocated by decreasing the prevalence and size of monopo­listic restrictions on output.

Gains of this sort can be important even when the differences in compara­tive advantage between trading countries are minimal. For example, one of the biggest sources of gain from intra-European trade in manufactured goods is the fact that such trade breaks down the strong monopolistic restrictions on output that would otherwise persist within the narrow confines of the typical European national market.

Greatly international competition. A fourth source of gain from trade is increased efficiency due to competition from foreign producers.

Because international trade exposes domestic producers to foreign com­petition, it puts pressure on domestic firms to operate as efficiently as possible.

For example, Indian steel plants are facing competition these days from foreign steel mills, and this puts pressure on Indian plants to adopt techno­logical advances that were developed abroad and that are already being widely used there.