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GAINS FROM TRADE:

The combination of consumer surplus and producer surplus obtained by buyers and sellers when engaging in a market exchange. Gains from trade arise because buyers are typically willing and able to pay a higher price to purchase a good than what they end up paying and because sellers are typically willing and able to accept a lower price to sell a good than what they end up receiving. Both sides of the market exchange are thus better off, have a net gain in welfare, by making the trade. While all types of market exchanges generate gains from trade, this topic is perhaps most important for an understanding of international trade.
Buyers and sellers engage in market exchanges because they benefit from the trade. As a generally rule both sides are better off after the exchange than they were before the exchange. Buyers are better off because they have a net gain in consumer surplus. Sellers are better off because they have a net gain in producer surplus.

Voluntary market exchanges are undertaken because they are beneficial to both sides of the transaction. If buyers and sellers did not gain from the trade, then they would not voluntarily undertake the trade.

While the gains obtained from market exchanges provides insight into all forms of trading and the very existence of a market-based economy used to allocate resources, it also provides a great deal of insight into trading among nations, that is, international trade. When two nations engage in trade they do so because they gain from the trade. Both countries are better off after the trade than they were before.

Market Trades

The motivation behind international trade is essentially the same as for any market exchange. People buy and sell goods because they expect to be better off after the exchange than they were before. To illustrate this, consider the motivation of two hypothetical people -- Horst Duncanstein and Francine von Sutter -- who are primed to do a little exchanging.
  • From the Buying Side: First, consider the situation facing Horst Duncanstein, who is exceptionally fond of turnip lasagna. Eating turnip lasagna makes Horst a happy fellow. It improves his level of well being. It satisfies his wants and needs.

    To this end, Horst is willing to pay a price for the turnips needed to make his turnip lasagna. Horst has a maximum price that he is willing to pay for the needed turnips -- a demand price. If the price is too high, then he will not purchase turnips, opting to consume another good, perhaps carrots to be used in a carrot casserole. However, should the price he pays for his turnips be less than his demand price, then he comes out ahead. He pays less than the value he receives, what is termed consumer surplus. He gains from this trade.

  • From the Selling Side: Second, consider the situation facing Francine von Sutter, a turnip farmer. While Francine does not have a particular fondness for turnips, she does enjoy the farming business. She has the land, labor, and capital needed to produce turnips.

    To this end, Francine is willing to provide turnips to willing buyers so long as she can cover the cost of production. Francine has a minimum price that she is willing to accept to produce turnips -- a supply price. If the price is too low, then she will not produce turnips, opting to produce another good, perhaps carrots. However, should the price she receives for her turnips be greater than her supply price, then she comes out ahead. She receives more than the cost of production incurred, what is termed producer surplus. She gains from this trade.
Putting Horst and Francine together is bound to be beneficial for both. If Horst pays less than his demand price, then he gains from the trade. If Francine receives more than her supply price, then she also gains from this trade. It is a win-win exchange.

In the extreme case, it is possible that the price Horst pays is exactly his demand price or the price Francine receives is exactly her supply price. In this case, one side or the other does not gain from the trade, but neither does that side lose.

However, should the price rise above the maximum demand price Horst is willing to pay or fall below the minimum supply price Francine is willing to pay, then the exchange will not occur. One side or the other will opt out of the trade.

The end result of such voluntary trades between buyers like Horst and sellers like Francine is that one side or the other, and usually both, gain from the trade. If they did not gain (or at least break even), then they would not voluntarily engage in the exchange.

Graphical Gains

Gains from Trade
Gains from Trade


The gains obtained from market exchanges can be illustrated using the exhibit to the right. This exhibit presents a standard market graph. The negatively-sloped demand curve, D, represents the demand price that buyers (like Horst) are willing and able to pay to purchase different quantities of turnips. The positively-sloped supply curve, S, represents the supply price that sellers (like Francine) are willing and able to accept to sell different quantities of turnips.

If this is a competitive market, free of other market failures and other annoying complications, then the intersection of the demand and supply curves gives rise to the equilibrium price and equilibrium quantity. The relation between the market equilibrium price, the demand price on the demand curve, and the supply on the supply curve indicates the gains from trade.

The area above the equilibrium price and below the demand curve is the consumer surplus generated by this market. Click the [Consumers' Surplus] button to highlight this area. The area below the equilibrium price and above the supply curve is the producer surplus generated by this market. Click the [Producers' Surplus] button to highlight this area.

The combination of these two areas, the area above the supply curve and below the demand curve, is the gains from trade generated by this market. This is extra satisfaction, welfare, profit, etc. that would not exist if this market exchange did not take place. A click of the [Total Gains] button highlights this area.

Gaining From International Trades

The only difference between regular market trades, such as that between Horst and Francine, and international trades is the location of the buyers and sellers. If Horst lives in one nation, such as the hypothetical Republic of Northwest Queoldiola, and Francine lives in another, such as the equally hypothetical United Provinces of Csonda, then the previous market exchange example is also an international trade. But the gains from trade still result.

As a matter of fact, Horst does live in the Republic of Northwest Queoldiola and like other Queoldiolan's, he loves his turnip lasagna. And Francine is a turnip-growing citizen of the United Provinces of Csonda, and she is eager to sell her product to buyers from other lands.

Horst and Francine gain from this turnip exchange, but so too do their home nations. Northwest Queoldiola ends up with a bit more consumer surplus, thanks to that obtained by Horst, and the Csonda ends up with bit more producer surplus, thanks to that obtained by Francine.

Winners and Losers

While Northwest Queoldiola gains when Horst has consumer surplus and Csonda gains when Francine has producer surplus, not everyone in the two nations win from this trade. An international trade has both winners and losers.
  • Winners: The winners in an international trade are the consumers in the buying (or importing) nation and the producers in the selling (or exporting) nation. The buyers receive consumer surplus and the sellers acquire producer surplus.

  • Losers: However, the losers in an international trade are the producers in the buying (or importing) nation and the consumers in the selling (or exporting) nation. The producers in the buying nation face greater competition for their products, which inevitably means lower prices and profits. The consumers in the selling nation also face greater competition for this domestic production, which is bound to cause higher prices.
For most international trades the winners win more than the losers lose, making such exchanges an overall win-win for both countries.

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Recommended Citation:

GAINS FROM TRADE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: December 13, 2017].


Check Out These Related Terms...

     | international economics | international finance | international trade | comparative advantage | absolute advantage | law of comparative advantage | foreign trade |


Or For A Little Background...

     | exports | imports | net exports | foreign sector | specialization | consumer surplus | producer surplus | demand price | supply price | voluntary exchange | market exchange | market | efficiency |


And For Further Study...

     | balance of trade | balance of trade surplus | balance of trade deficit | balance of payments | international market | foreign trade policies | tariffs | import quotas | export subsidies | terms of trade | foreign exchange market |


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