CA Foundation · Business Economics · International Trade
When a free trade agreement leads a country to buy a product from a partner country at a higher cost than the cheapest world producer, because the partner's goods now face no tariff, the effect is known as:
This is trade diversion. Imports shift from the lowest-cost world supplier outside the bloc to a higher-cost member, only because the member enjoys tariff-free access. It reduces efficiency, unlike trade creation, where cheaper member imports replace costlier domestic production.
- ATrade creation
- BTrade diversionCorrect
- CDumping
- DTerms of trade effect
Explanation
Trade diversion shifts imports from a more efficient non-member to a less efficient member because of the tariff preference. This lowers efficiency. Trade creation, by contrast, replaces costly domestic production with cheaper imports from a member, which is a gain. Dumping is selling abroad below cost or home price.
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