Th4.1: Trade Creation and Diversion Flashcards
What will the costs and benefits of trading blocs depend on?
whether they lead to trade creation or trade diversion
What is trade creation?
when a country moves from buying goods from a high cost to a lower cost country
What is trade diversion?
when they go from low cost to higher cost
Trade creation is when trade is…
created by the joining of a union. it is when consumption shifts from a high cost domestic producer to a low cost partner producer
Refer to PP
Look at Graph 16. What is the trade creation diagram like?
the opposite of the tariff diagram, since it removes the tariffs and leads to welfare gain and higher consumer surplus
When does trade diversion occur?
when consumption shifts from a lower cost producer outside the training bloc to a higher cost producer within it
Refer to PP
Look at Graph 16. What does this diagram show?
how the UK will buy from the EU without tariffs rather than New Zealand without tariffs
Refer to PP
Look at Graph 16. Where would they have bought at and from whom and where do they buy at and from whom?
would have bought Q3-Q4 from New Zealand and gained tax revenue of C+E
instead buy Q2-Q1 from the EU
Refer to PP
Look at Graph 16. What do each of the letters represent?
A - producer surplus being switched to consumer surplus B - welfare gain given to customers C - switched to consumer surplus D - welfare gain given to customers E - EU producers will gain E in profit
Refer to PP
Look at Graph 16. What happens if B+D is greater than E?
the UK has gained, but if they are smaller the UK has lost out!
When is a trading bloc more likely to lead to trade diversion than trade creation?
when it has a very high external tariff as this will push countries to buy from within the bloc or if there is a relatively small cost difference between goods purchased within and outside the bloc
The higher the tariffs imposed by a country before joining the market…
the more likely it is that trade creation rather than diversion will take place
When is it welfare improving?
if joining an FTA leads to more trade creation than diversion
When is it reducing welfare?
if it leads to more diversion than creation
