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CFA Level I · CFA Level I Exam · International Trade

A customs union shifts a member country's imports of a good from a non-member producer with a cost of 80 per unit to a partner producer with a cost of 90 per unit, because the common external tariff makes the non-member price 100 including tariff. This outcome is best described as:

This is trade diversion. Imports shift from a lower-cost non-member at 80 to a higher-cost partner at 90 only because the external tariff raises the non-member price to 100. Production moves to a less efficient source, which most likely reduces global efficiency.

  1. Atrade creation, which raises the member country's welfare
  2. Btrade diversion, which most likely reduces global efficiencyCorrect
  3. Ctrade creation, which lowers the partner country's welfare

Explanation

Imports move from a lower-cost non-member (80) to a higher-cost member (90) only because of the tariff. That is trade diversion, which shifts production to a less efficient producer and tends to reduce efficiency. Trade creation would replace higher-cost domestic production with lower-cost partner imports.

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