CFA Level I · CFA Level I Exam · International Trade
Country X joins a customs union. Before joining, it produced a good domestically at 120 per unit with a tariff on imports. After joining, it imports the good from a union partner at 95 per unit, and the domestic industry closes. The most likely net effect of this change is:
This is trade creation. Higher-cost domestic production at 120 is replaced by cheaper imports from a partner at 95, so resources move to a more efficient source. Trade diversion would instead require switching from a lower-cost non-member to a higher-cost member.
- Atrade diversion, because a domestic producer closes
- Btrade creation, because lower-cost partner supply replaces higher-cost domestic productionCorrect
- Cno change in welfare, because the external tariff is unchanged
Explanation
Higher-cost domestic production (120) is replaced by lower-cost imports from a partner (95). That is trade creation, which raises efficiency and welfare. Trade diversion requires imports to shift from a lower-cost non-member.
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