Trade Creation – Removing Tariffs to Import at Lower World PricesHL
Global EconomicsThis diagram illustrates trade creation: when a country removes a tariff on imports and begins buying goods at the lower world price rather than producing them domestically at a higher cost. As tariffs are removed, the domestic price falls from the tariff-inclusive price to the world price, imports increase, and consumer welfare rises. The economy becomes more efficient because resources shift from high-cost domestic production to lower-cost international suppliers.
Curves and elements
- world price
- World Price: The lower price IBonomica can buy imports for once the tariff is removed.
- world price tariff
- World Price + Tariff: The higher domestic price when the tariff was in place.
- domestic supply
- Domestic Supply (Sd): High-cost domestic producers supplying more when protected by tariffs.
- domestic demand
- Domestic Demand (Dd): Consumers increasing quantity demanded when the tariff is removed.
Key explanations
- 1
Initially, the tariff raises the domestic price to 'World Price + Tariff', causing higher prices for consumers and limiting imports.
- 2
When the tariff is removed, the domestic price falls to the lower 'World Price', making foreign goods cheaper for consumers.
- 3
Imports expand from the smaller range (Q1–Q2) to a much larger range (Q3–Q4), representing increased trade with more efficient foreign producers.
- 4
Consumers gain welfare because they now pay a lower price, shown by the green welfare-gain areas in the diagram.
- 5
Government revenue disappears, but society overall benefits because the loss is smaller than the efficiency gain created by cheaper imports.
Example exam question
Using the trade creation diagram, explain why removing tariffs increases economic efficiency and benefits consumers.
Show example answer
Trade creation occurs when a tariff is removed and the domestic price falls to the lower world price. As shown in the diagram, consumers now pay less and import more, gaining welfare. Although the government loses tariff revenue, the efficiency gain is larger because production shifts away from expensive domestic producers toward lower-cost world suppliers. This makes the economy more efficient overall.
