Trade Diversion and Trade Creation Essay Example | Topics and Well Written Essays - 1750 words

Trade Diversion and Trade Creation - Essay Example The concept of trade creation and the trade diversion is based on the cost of production and the value of the outcomes among countries or regions. Trade creation arises because of trade deals that occur between different countries that are involved in a spending shift by the domestic consumers. The agreement aims at moving local consumer expenditure from higher cost source domestic spending to a lower cost source partner spending (El-Agraa and El-Agraa, 2007). To clarify the concept of trade diversion, take an example of two countries within the EU that have signed a trading agreement. Taking in country A and country B. Country A households can switch their spending on insurance and cars supplied by its domestic suppliers at a higher cost to those provided by country B suppliers at a lower cost operating in the same market. The primary essence of trade creation is to encourage an upsurge in trade among countries that enter an agreement by signing the trade accord (Laine, 2011). The trade creation also leads to an efficient allocation of limited resources and raises gain in user and manufacturer welfare. Below is a diagram showing both the domestic supply and the internal demand for trade creation in the European Countries. The diagram demonstrates that access to cheaper supplies allows a lower price, which benefits the final consumer. The diagram also shows that a reduction in price that leads to an expansion in demand thus an increase in consumer surplus. The incurred surplus further leads to a net improvement in the country’s economic welfare. On the other hand, trade diversion is best defined as a change in local customer speeding from a zone of lower cost source to an area of higher partner cost source. It occurs because of the removal of tariffs on the imports acquired from the other partner countries. Trade diversion is commonly based on the existing tariffs on the external imports of the goods and services.