key term - Trade Creation

Definition

Trade creation refers to the increase in trade that occurs when countries form a trade agreement or economic union, such as a free trade area or customs union. It describes the expansion of trade between member countries as a result of the reduction or elimination of tariffs and other trade barriers.

5 Must Know Facts For Your Next Test

1. Trade creation leads to an increase in economic welfare for member countries by allowing them to specialize in the production of goods they can make most efficiently.
2. Trade creation occurs when a trade agreement reduces or eliminates tariffs, allowing member countries to import goods more cheaply from each other, leading to an increase in trade.
3. The magnitude of trade creation depends on the size of the tariff reduction, the price elasticity of demand, and the degree of comparative advantage between member countries.
4. Trade creation is more likely to occur when member countries have significant differences in their comparative advantages, allowing for greater specialization and gains from trade.
5. Governments often pursue trade creation through regional trade agreements (RTAs) or free trade agreements (FTAs) to expand market access and increase economic growth for their domestic industries.

Review Questions

• Explain how trade creation occurs within a trade agreement or economic union.
  • Trade creation occurs when a trade agreement, such as a free trade area or customs union, reduces or eliminates tariffs between member countries. This allows member countries to import goods more cheaply from each other, leading to an increase in trade. The magnitude of trade creation depends on the size of the tariff reduction, the price elasticity of demand, and the degree of comparative advantage between member countries. Trade creation is more likely to occur when member countries have significant differences in their comparative advantages, allowing for greater specialization and gains from trade.
• Describe the relationship between trade creation and economic welfare for member countries in a trade agreement.
  • Trade creation leads to an increase in economic welfare for member countries by allowing them to specialize in the production of goods they can make most efficiently. This specialization and the resulting increase in trade leads to a more efficient allocation of resources, lower consumer prices, and higher overall economic output. The gains from trade creation are particularly significant when member countries have complementary comparative advantages, enabling them to exploit their differences and engage in mutually beneficial exchange.
• Analyze the role of governments in pursuing trade creation through regional trade agreements (RTAs) or free trade agreements (FTAs).
  • Governments often pursue trade creation through the establishment of regional trade agreements (RTAs) or free trade agreements (FTAs) as a means of expanding market access and increasing economic growth for their domestic industries. By reducing or eliminating tariffs and other trade barriers between member countries, these agreements facilitate the flow of goods and services, allowing for greater specialization and gains from trade. Governments view trade creation as a way to boost the competitiveness of their domestic firms, increase consumer welfare through lower prices, and foster economic integration and cooperation among member countries. The pursuit of trade creation through RTAs and FTAs is a key component of many countries' trade and economic policies.

Related terms

Trade Diversion:

Trade diversion is the shift in trade from a more efficient non-member country to a less efficient member country within a trade agreement, due to the preferential tariff treatment given to member countries.

Comparative Advantage:

Comparative advantage is the ability of a country to produce a good more efficiently than another country, leading to specialization and increased trade between the countries.

Customs Union: A customs union is a type of trade agreement where member countries eliminate tariffs on trade between themselves and adopt a common external tariff on imports from non-member countries.