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In this Graph P is the price at which the product inside the customs union is supplied at. Before the nation enters into the customs union it places a tariff on the good in the domestic market of P1. This means at P1, Domestic Demand is at 0C. However at this price domestic supply is only at 0B. This means that the nation has to import BC. However when the nation enters the customs union, the price falls to P. This results in Domestic Demand increasing to 0D and Domestic Supply decreasing from 0B to 0A. This means that imports to the country have now increased from BC to AD. The difference between BC and AD is called trade creation.
Before entry into the EU the UK as a whole demanded 0D food, and was subjected to World Prices so had to import AD. However when the UK joined the EU the price of food from external countries increased to P+T. As a result domestic demand for say Australian food fell from 0D to 0C. This means it is not cheaper to import from France or Germany than it is the USA or Canada.
Trade Deflection Creation and Diversion
ECON4 TradeDeflection | Creation | Diversion Aquinas College Economics Department
Trade Deflection “Redirection of international trade due to the formation of a free trade area” This can be a massive problem in Free Trade Areas. Aquinas College Economics Department
Prior to Free Trade Area France Before a Free Trade Area an exporting company would have €0.50 to pay Export Tariffs on goods to be in every country When countries enter into FTAs it removes the barriersGermany Exporting UK between countries such as the €3.40 Company €1.10 tariffs are removed This creates benefits for Exporting Companies but problems for the other countries Spain €4.70 Aquinas College Economics Department
During a Free Trade Area France With the tariffs removed €0.50 between the other countries an Exporting company would simply export all the goods for the European Market into the country with the lowest external tariff – In this case itGermany Exporting UK is France with a tariff of €0.50. €3.40 Company €1.10 Then it moves the goods around the free trade area without the external tariffs Spain €4.70 Aquinas College Economics Department
Ways around Trade Deflection• Rules of Origin – These can be imposed to stop exporting companies from outside the area from doing this – These are actively in force in the European Union today Aquinas College Economics Department
Trade CreationExists when an increase in trade results inthe rolling back of trade barrier i.e. tariffsTypically this happens when a country joinsa customs unionConsumers benefit because effectivley thedomestic tariff free market has expanded Aquinas College Economics Department
Price Trade Creation DS Price with tariffP1 Customs Union PriceP DD0 A B C D Quantity Aquinas College Economics Department
Price Trade Creation Net Gain to Country DS Price with tariffP1 GOVT. Lost Revenue Customs Union PriceP DD0 A B C D Quantity Aquinas College Economics Department
Trade DiversionProblem arises when a country has to pay moreas a result of a Common External TariffIt can be seen to subsiding inefficient industrieswithin a customs unionPreviously the UK could buy food cheaper fromUSA than France, however this changed when itentered the Union Aquinas College Economics Department
Price Trade Diversion DS EU Price with tariffP+T World PriceP DD0 A B C D Quantity Aquinas College Economics Department