Question

Upon Poland’s entering the European Union, suppose it is discovered that the cost of automobile production in Poland is Euro10,000 while it is Euro20,000 in Germany. Suppose the EU, which has a customs union, has an X percent tariff on automobiles and the costs of production are equal to Y (valued in euros) in Japan. Comment on whether the addition of Poland to the European Union would result in trade creation or trade diversion under the following scenarios:
X = 50% and Y = Euro 8,000
X = 100% and Y = Euro 8,000
X = 100% and Y = Euro2,000

Answer 1

Trade creation will mean that consumption shifts from a high-cost producer to a low-cost producer and trade therefore expands. Trade diversion on the other hand means that trade shifts from a lower cost producer outside the union to a higher cost producer inside the union.

The addition of Poland to the European Union would result in trade diversion under Scenario 1, trade diversion under Scenario 2, and trade creation under Scenario 3.