Trade diversion SFLS
42
Economic Integration: 1.) Regional Economic Integration 2.) Trade Creation/ Diversion
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Transcript of Trade diversion SFLS
Economic Integration:
1.) Regional Economic Integration
2.) Trade Creation/ Diversion
Trade Creation higher priced domestic output replaced by lower priced imports
increases welfare
Country A
Country B
$20 $15
Buyer
2.) Trade Creation / Diversion
P
Q
D
S
$15
Q1
$20
Q2
imports
A Country That Imports LEGOSTrade Creation
Country A is importing from
country B
Trade Creation
Country A
Country B
$20$15
Buyer
Free Trade Area
$10
2.) Trade Creation / Diversion
If remove the tariffs on country B with a Free Trade Area for example…
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
A Country That Imports LEGOS
Trade creation!
Reduce Tariffs
Trade Creation
Free Trade Area
Example:
Result in lower prices, more
imports.
$30
P
Q
D
S
$20
25
Cotton shirts
40
A
B
D E
G
FC
70 80
deadweight
loss = D + F
Remember this…..?
In stead of adding a tariff and making a deadweight loss…
Now we are starting with a tariff and removing it making Trade Creation!
神奇! $15
P
Q
D
S
$10imports
$30
P
Q
D
S
$20
25
Cotton shirts
40
A
B
D E
G
FC
70 80
deadweight
loss = D + F
Remember this…..?
In stead of adding a tariff and making a deadweight loss…
Now we are starting with a tariff and removing it making Trade Creation!
神奇! $15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
Trade creation!
Trade Diversion trade diverted from low cost to high cost supplier
decreases welfare
Country BCountry A
Country C$20 $10$15
Buyer
2.) Trade Creation / Diversion
Trade Diversion
2.) Trade Creation / Diversion- Lower cost imports from outside the union are
replaced by higher cost imports from member unions.
- Preferential trade treatment – result in the financing of inefficiency within a union.
- Trade –diverting union results in both trade creation and diversion and strength depends on the relative strength.
- Can increase or reduce welfare of members.
Trade Diversion trade diverted from low cost to high cost supplier
decreases welfare
Country BCountry A
Country C$20 $10$15
Buyer
2.) Trade Creation / Diversion
Trade Diversion
Country BCountry A
Country C$20 $10$15
Buyer
2.) Trade Creation / Diversion
So for example, Country A is buying stuff from country B and NOT country C
Country BCountry A
Country C$20 $10$15
$17
Buyer
2.) Trade Creation / DiversionTrade Diversion Now Country A and Country C create a
Customs Union against Country B and impose tariffs
P
Q
D
S
$10
Q3 Q4
imports
A Country That Imports LEGOSTrade Diversion
Customs Union
Old Price of B
Example:
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
A Country That Imports LEGOSTrade Diversion
Customs Union
Old Price of B
Price of C
Example:Loss of Welfare
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
A Country That Imports LEGOSTrade Diversion
Customs Union
Old Price of B
Price of C
$17
New Price of B
Example:
Trade diverted to partners producer surplus!
Theory of Second Best Some forms economic integration may
increase or decrease welfare of member nations and the world depending on circumstances under which it takes place.
2.) Trade Creation / DiversionTrade Diversion trade diverted from low cost to high cost
supplier decreases welfare
Integration is often good but this diversion might occur for some sectors of the economy, though there
might be justified political, social or historical reasons to do it anyway
Trade Diversion
2.) Trade Creation / Diversion- Lower cost imports from outside the union are
replaced by higher cost imports from member unions.
- Preferential trade treatment – result in the financing of inefficiency within a union.
- Trade –diverting union results in both trade creation and diversion and strength depends on the relative strength.
- Can increase or reduce welfare of members.
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
Loss of Welfare
Trade Diversion
Old Price of B
Price of C
$17
New Price of B
Loss of Welfare
In this example it was assumed that the trading price was originally the old price of B which is the Free Trade price…
But what if we started at the new price of B?
What if we started with the tariff price?
2.) Trade Creation / Diversion
Without Trade,
CS = A
PS = B + C
Total surplus
= A + B + C
With Free Trade,
CS = A + B + D
PS = C
Total surplus
= A + B + C + D
P
Q
D
S
1500
3000
Cars
A
B D
C
gains
from trade
imports
Remember this…..?
country A’s P
P
Q
D
S
25
Cotton shirts
40
A
B
D E
G
FC
70 80
So now this…..
This was with 2 countries…
Let’s call them country Aand country B…
B’s P with Tariff
country B’s P
country A’s P
P
Q
D
S
25
Cotton shirts
40
A
B
D E
G
FC
70 80
So now this…..
This was with 2 countries…
Now we’re going the add another country’s price in here in between the tariff price…
Let’s call them country Aand country B…
Let’s call that country Ccountry C’s P
B’s P with Tariff
Country A and country C are going to form a customs union together…
country B’s P
country A’s P
P
Q
D
S
country B’s P
25
Cotton shirts
40
A
B
D E
G
FC
70 80
So now this…..It will matter where country C’s price is inserted to know if the customs union is a good thing or not…
This might be a net loss for country A
If it’s inserted closer to the tariff price…
country C’s P
B’s P with Tarrif
country A’s P
P
Q
D
S
country B’s P
25
Cotton shirts
40
A
B
D E
G
FC
70 80
So now this…..It will matter where country C’s price is inserted to know if the customs union is a good thing or not…
If‘ it’s inserted closer to B’sfree trade price…
country C’s P
B’s P with Tarrif
This might be a net gain for country A
P
QD
S
Q1 Q2
B +T
2.) Trade Diversion – join Customs Union = Net Loss
A
B
Starting at Price B +T …
Consumer surplus
Producer surplus
Government Revenue
Total surplus
A
B
E
G
D
F
C
= A +B
= C + D
= G
= A + B + C + D + G
P
QD
S
Q1 Q2
B +T
2.) Trade Diversion – join Customs Union = Net Loss
A
B
Starting at Price B +T …
Consumer surplus
Producer surplus
Government Revenue
Total surplus
A
B
E
G
D
F
C
= A +B
= C + D
= G
= A + B + C + D + G
C
Join with Country C to make a customs union and C is a high price producer…
P
QD
S
2.) Trade Diversion – join Customs Union = Net Loss
A
B
E.2
D
F.2
C
Divide up the areas a little more…
C.2 G.2
Consumer surplus
= A +B + C.1 + E.1 + G.1 + F.1
Q1 Q2
A
BG.1C.1 E.1 F.1
Producer surplus
= C.2 + D
Government Revenue = nothing!
Total surplus
= A + B + C.1 + C.2 + D + E.1 + F.1 + G.1
B +T
P
QD
S
2.) Trade Diversion – join Customs Union = Net Loss
A
B
E.2
D
F.2
C
Divide up the areas a little more…
C.2 G.2
Consumer surplus
= A +B + C.1 + E.1 + G.1 + F.1
Q1 Q2
A
BG.1C.1
Producer surplus
= C.2 + D
Government Revenue = nothing!
Total surplus
= A + B + C.1 + C.2 + D + E.1 + F.1 + G.1
B +T
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
F.1E.1
P
QD
S
2.) Trade Diversion – join Customs Union = Net Loss
A
E.2
D
F.2
C
C.2
Q1
A
BG.1C.1 E.1 F.1
G.2
If E.1 + F.1 G.2
= net loss in welfare in this country.
The imported amount has been diverted away and the loss of government revenue is more than the gains in trade.
Q3 Q4
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
B +T
B
Q2
P
QD
S
Q1 Q2
B +T
2.) Trade Diversion – join Customs Union = Net Gain
A
B
Net Gain now..Starting at Price B +T …
Consumer surplus
Producer surplus
Government Revenue
Total surplus
A
B
EG
D
FC
= A +B
= C + D
= G
= A + B + C + D + G
P
QD
S
Q1 Q2
B +T
2.) Trade Diversion – join Customs Union = Net Gain
A
B
Net Gain now..Starting at Price B +T …
Consumer surplus
Producer surplus
Government Revenue
Total surplus
A
B
EG
D
FC
= A +B
= C + D
= G
= A + B + C + D + G
C
Join with Country C to make a customs union and C is a relatively lower price producer…
Q3 Q4
P
QD
S
A
B
E.2
D
F.2
Divide up the areas a little more…
C.2 G.2
Consumer surplus
= A +B + C.1 + E.1 + G.1 + F.1
Q1 Q2
A
B
G.1C.1E.1 F.1
Producer surplus
= C.2 + D
Government Revenue = nothing!
Total surplus
= A + B + C.1 + C.2 + D + E.1 + F.1 + G.1
B +T
2.) Trade Diversion – join Customs Union = Net Gain
C
Q3 Q4
P
QD
S
A
B
E.2
D
F.2
Divide up the areas a little more…
C.2 G.2
Consumer surplus
= A +B + C.1 + E.1 + G.1 + F.1
Q1 Q2
A
B
G.1C.1E.1 F.1
Producer surplus
= C.2 + D
Government Revenue = nothing!
Total surplus
= A + B + C.1 + C.2 + D + E.1 + F.1 + G.1
B +T
2.) Trade Diversion – join Customs Union = Net Gain
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
C
Q3 Q4
P
QD
S
2.) Trade Diversion – join Customs Union = Net Gain
A
B
E.2
D
F.2C.2 G.2
Q1 Q2
A
B
G.1C.1E.1 F.1
B +T
If E.1 + F.1 G.2
= net gain in welfare in this country.
The imported amount has been diverted away and the loss of government revenue is less than the gains in trade.
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
C
Q3 Q4
So to summarize…
Stages of integration
Free imports &exports
CommonExternal Tariff
FreeFactors of production movement
Common Currency
Common Economic Policy
Free Trade Area
Customs Union
CommonMarket
Monetary Union
Economic Union
1.) Regional Economic Integration
Trade Creation higher priced domestic output replaced by lower priced imports
increases welfare
Country A
Country B
$20 $15
Buyer
Free Trade Area
$10
2.) Trade Creation / Diversion
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
A Country That Imports LEGOS
Trade creation!
Reduce Tariffs
Trade Creation
Free Trade Area
Example:
Country BCountry A
Country C$20 $10$15
$17
Buyer
2.) Trade Creation / DiversionTrade Diversion trade diverted from low cost to high cost
supplier decreases welfare
$15
P
Q
D
S
$10
Q3 Q1 Q2 Q4
imports
A Country That Imports LEGOS
Trade diverted to partners producer surplus!
Trade Diversion
Customs Union
Old Price of B
Price of C
$17
New Price of B
Loss of Welfare
Example:
P
QD
S
2.) Trade Diversion – join Customs Union = Net Loss
A
E.2
D
F.2
C’s P
C.2
Q1
A
BG.1C.1 E.1 F.1
G.2
If E.1 + F.1 G.2
= net loss in welfare in this country.
The imported amount has been diverted away and the loss of government revenue is more than the gains in trade.
Q3 Q4
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
B +T
B
Q2
P
QD
S
2.) Trade Diversion – join Customs Union = Net Gain
A
B
E.2
D
F.2
C’s P
C.2 G.2
Q1 Q2
A
B
G.1C.1E.1 F.1
B +T
If E.1 + F.1 G.2
= net gain in welfare in this country.
The imported amount has been diverted away and the loss of government revenue is more than the gains in trade.
Total Gain from Trade= E.1 + F.1Total Loss from Trade= G.2
Q3 Q4
The End
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