Economics – Globalisation | e-Consult

Answer:

Trade Creation: A tariff on imports from France makes French goods more expensive in Britain. This encourages British consumers and firms to switch from buying from domestic producers (Britain) to buying from France. This is trade creation because it leads to an increase in trade with the producer who is now selling at a higher price (France). The diagram shows an increase in the quantity of imports from France to Britain after the tariff.

Trade Diversion: The tariff makes French goods relatively more expensive in Britain compared to other potential suppliers. This discourages British consumers and firms from buying from other countries (potentially more efficient producers) and encourages them to buy from France. This is trade diversion because it leads to a decrease in trade with a more efficient producer (the alternative supplier) and an increase in trade with a less efficient producer (France). The diagram shows a decrease in imports from the alternative supplier (e.g., Germany) and an increase in imports from France.

In summary, the tariff shifts the pattern of trade, leading to increased trade with the protected producer (trade creation) and decreased trade with more efficient producers (trade diversion). The net effect on overall welfare is ambiguous and depends on the relative magnitudes of the gains and losses.