trade creation and trade diversion

Globalisation 🌍

Think of globalisation as a huge international shopping mall. Countries are the shops, and goods, services, and ideas are the items you can buy and sell. Because the mall has no locked doors, people can move freely across borders, making trade easier and faster.

Trade Creation 🚀

When two or more countries sign a Free Trade Agreement (FTA) and remove tariffs, they create new trade opportunities. It’s like building a brand‑new highway between two towns that were previously separated by a toll road.

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  Lower costs: Importers pay less because tariffs are gone.

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  Increased volume: More goods flow because it’s cheaper.

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  Consumer benefit: Cheaper products and more choices.

Mathematically, the change in trade volume can be shown as:

\$ΔT = T{\text{old}} - T{\text{new}}\$

where \$T{\text{old}}\$ is trade before the FTA and \$T{\text{new}}\$ after.

Trade Diversion 🔄

Trade diversion happens when an FTA makes a country trade more with a partner that is not the most efficient producer, simply because tariffs are lower. Imagine you choose a local bakery that sells slightly worse bread because it’s cheaper, even though a distant bakery makes better bread.

1. 🚧 Tariff advantage: Country A prefers Country B over Country C because tariffs are lower.
2. 🚧 Efficiency loss: Country C is actually better at producing the good.
3. 🚧 Net welfare impact: Overall welfare may fall because resources are not used efficiently.

Exam Tips 📚

• 🔍 Define clearly: Start with a concise definition of trade creation and trade diversion.
• 🔍 Use diagrams: Sketch a simple supply‑and‑demand diagram showing tariff changes.
• 🔍 Include examples: Refer to real FTAs (e.g., EU, US‑MEX‑CAN) to illustrate concepts.
• 🔍 Explain welfare: Discuss how trade creation usually increases welfare, while trade diversion can reduce it.
• 🔍 Answer structure: Use the define, explain, illustrate, evaluate format.

Quick Reference Table 📊