Pearson Edexcel · A-Level · Economics B
Course version: 9EB0 · Version from Sept 2015
Trading blocs: a) Trade creation and trade diversion
Trade creation and trade diversion evaluate the economic impact of joining a trading bloc like a customs union.
Checked against the Pearson Edexcel 9EB0 specification (opens in a new tab) on .
- Point 1 of 3
- 2 key terms
Study notes
From the checked teaching notes for this specification point.
The idea
Trade creation and trade diversion evaluate the economic impact of joining a trading bloc like a customs union. Trade creation occurs when removing internal tariffs shifts production from a higher-cost domestic producer to a lower-cost producer within the bloc, increasing efficiency and consumer welfare. Conversely, trade diversion happens when a country switches from a lower-cost producer outside the bloc to a higher-cost producer inside the bloc, due to a common external tariff.
For example: If a nation joins a bloc and stops importing cheap goods from a non-member in favour of more expensive goods from a member, this is trade diversion, which reduces global economic efficiency and can harm consumer welfare.
What earns the marks
- Define trade creation as the shift from high-cost domestic production to lower-cost production within a trading bloc.
- Define trade diversion as the shift from low-cost production outside a trading bloc to higher-cost production within it.
- Explain that trade creation increases economic welfare by improving resource allocation and lowering prices for consumers.
- Explain that trade diversion decreases global economic welfare because it shifts production away from the most efficient global producers.
- Apply the concepts of trade creation and diversion to specific examples of customs unions or free trade areas.
Common mistakes and how to put them right
Confusing trade creation with a general increase in exports.
Put it right: Trade creation specifically refers to the shift in production to a more efficient member country due to the removal of trade barriers.
Assuming joining a trading bloc always improves economic welfare.
Put it right: Welfare only improves if the benefits of trade creation outweigh the costs of trade diversion.
Misunderstanding the cause of trade diversion.
Put it right: Trade diversion is caused by the discriminatory nature of a bloc's common external tariff against non-members, not by internal inefficiencies.
Exam tips
- Use comparative advantage to explain why trade creation improves efficiency, as countries specialise in what they produce best.
- When evaluating a trading bloc, always weigh the positive welfare effects of trade creation against the negative welfare effects of trade diversion.
- Remember that trade diversion is most commonly associated with customs unions, where a common external tariff is applied to non-members.
Try the lesson
The start of the Trading blocs: a) Trade creation and trade diversion lesson, made from checked teaching notes for this specification point.
Have a go first
Following the formation of a customs union, Country X stops importing steel from a low-cost non-member country and instead imports it from a higher-cost member country due to the removal of internal tariffs. Which economic concept does this scenario directly illustrate?
Listen
Trade creation and trade diversion evaluate the economic impact of joining a trading bloc like a customs union. Trade creation occurs when removing internal tariffs shifts production from a higher-cost domestic producer to a lower-cost producer within the bloc, increasing efficiency and consumer welfare. Conversely, trade diversion happens when a country switches from a lower-cost producer outside the bloc to a higher-cost producer inside the bloc, due to a common external tariff. For example, if a nation joins a bloc and stops importing cheap goods from a non-member in favour of more expensive goods from a member, this is trade diversion, which reduces global economic efficiency and can harm consumer welfare. A strong answer earns marks for these points. Define trade creation as the shift from high-cost domestic production to lower-cost production within a trading bloc. Define trade diversion as the shift from low-cost production outside a trading bloc to higher-cost production within it. Explain that trade creation increases economic welfare by improving resource allocation and lowering prices for consumers. Explain that trade diversion decreases global economic welfare because it shifts production away from the most efficient global producers. A common slip: Confusing trade creation with a general increase in exports. Instead, trade creation specifically refers to the shift in production to a more efficient member country due to the removal of trade barriers. Exam tip: Use comparative advantage to explain why trade creation improves efficiency, as countries specialise in what they produce best.
See it
Key words
Say what each word means before you turn the card.
Trade creation
Try answering aloud or in your head before turning the card.
Trade diversion
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See every definition
- Trade creation
- The shift from high-cost domestic production to lower-cost production within a trading bloc when internal tariffs are removed.
- Trade diversion
- The shift from low-cost production outside a trading bloc to higher-cost production within it, due to a common external tariff.
Label the diagram
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1Box 1
2Box 2
3Box 3
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