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The Simple Analytics of Trade Creation and Diversion

Author

Listed:
  • Alan V. Deardorff

    (University of Michigan)

  • Rishi R. Sharma

    (Colgate University)

Abstract

This paper conducts analysis of a free trade agreement within a simple model of partial equilibrium, linear supply and demand, and circumstances such that trade flows are positive in all equilibria considered. The results illustrate the close connection, on the one hand, between trade creation and the benefit to the FTA-forming countries and to the world, and, on the other hand, the equally close connection between trade diversion and the harm to outside countries and potentially both the participating countries and the world. In addition, by considering a second case in which a country that already has one FTA adds another, we show that the new FTA causes trade to be diverted from its prior partner, an effect that we call trade reversion. It turns out that trade reversion causes neither harm nor benefit to the importing country, and when we look at world welfare, if trade reversion is equal to trade diversion their two effects cancel out, leading the effect on world welfare to be a simple function of the amount of trade creation and the size of the tariff.

Suggested Citation

  • Alan V. Deardorff & Rishi R. Sharma, "undated". "The Simple Analytics of Trade Creation and Diversion," Working Papers 670, Research Seminar in International Economics, University of Michigan.
    • Handle: RePEc:mie:wpaper:670
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    File URL: http://www.fordschool.umich.edu/rsie/workingpapers/Papers651-675/r670.pdf
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    References listed on IDEAS

    as
    1. Alan V. Deardorff & Rishi R. Sharma, 2021. "Exempted sectors in free trade agreements," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(1), pages 284-310, February.
    2. Alan V. Deardorff, 2014. "Trade Implications of the Trans-Pacific Partnership for ASEAN and Other Asian Countries," Asian Development Review, MIT Press, vol. 31(2), pages 1-20, September.
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    Cited by:

    1. Alan V. Deardorff & Rishi R. Sharma, 2021. "Exempted sectors in free trade agreements," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(1), pages 284-310, February.

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    More about this item

    Keywords

    FTAs; Trade creation; trade diversion;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations

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