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

• 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.

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

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

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

• 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.