Section IV Trade Creation and Trade Diversion

Trade Creation  The Trade creation effect refers to the increased output by members of a trade block as a result of the adoption of free trade between them. Specialization and economies of scale increase the productive efficiency of member countries. Specialization and economies of scale increase the productive efficiency of member countries.

The effect of a tariff on welfare and consumer surplus Q P D (France) S (France) S (UK) P (UK) Qd2Qs2 P (UK) + tariff Qd1Qs1 Trade will result into higher world welfare gain as well as an increase in consumer surplus. S (UK) + tariff

Trade Diversion The trade diversion effect refers to the loss that occurs when protection results in buying goods from within the trade block that could otherwise have been obtained for a lower price from outside the block.

Quantity Price D S Q1Q1 P1P1 S Block Q2Q2 P2P2 SWSW PWPW Q3Q3 Trade Diversion Trade Creation

Obstacles to economic integration Those who oppose trade integration argue that:  Economic integration takes away the country’s political & economic sovereignty. If integration reaches the stage of custom unions, political decisions will be made by a central government reducing the power of the domestic government. If integration reaches the stage of custom unions, political decisions will be made by a central government reducing the power of the domestic government. European Parliament making decisions for EU countries. European Parliament making decisions for EU countries. European central bank deciding on interest rates. European central bank deciding on interest rates.  The stronger the economic integration the more member countries will lose control over economic and political matters.

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