Suppose Colombia joins a trade bloc formed by Argentina, Brazil, Paraguay, and Uruguay. Before joining the trade bloc, the Colombian government has a tariff of 30 percent on imported meat, and Colombia's imports of 40,000 tons of meat came exclusively from the United States. The United States sold meat at a price of $2,000 per ton in the international market. After joining the trade bloc, Colombia switched to importing meat from the other member countries at a price of $2,100 per ton. Its imports increased to 50,000 tons. Calculate the amount of trade creation and trade diversion as a result of this change. For this product, did Colombia gain economic well-being from joining the trade bloc? If so, then how much? If not, then what is the minimum amount that Colombian imports of meat would
have to increase for Colombia to benefit from joining the trade bloc?
What will be an ideal response?
POSSIBLE RESPONSE: The tariff-inclusive price of meat imported from the United States to Colombia is (30% × $2,000) + $2,000 or $2,600 per ton. The trade creation gain for Colombia is thus the increase in imports, i.e., (50,000 - 40,000) tons multiplied by the difference in price paid by the domestic consumers, ($2,600 - $2,100), divided by two. This equals (10,000 × $500/2) = $2,500,000. The trade diversion loss for Colombia is the effect caused by the shift of trade volume from the low-cost U.S. exporters to the higher-cost bloc partners. It equals [40,000 × ($2,100 - $2,000)] = (40,000 × $100) = $4,000,000. Because the trade diversion exceeds the trade creation, we conclude that Colombia lost welfare by joining the trade bloc. The welfare loss is estimated at ($4,000,000 - $2,500,000) = $1,500,000.
Let Colombia's imports of meat increase by the Quantity Z after joining the trade bloc. For the trade creation gain to exceed the trade diversion loss, the inequality ($500 × Z)/ 2 > $4,000,000 must hold. Thus, imports would have to increase by a little more than ($4,000,000 / $500) × 2 = 8,000 × 2 = 16,000 tons for Colombia to benefit from joining the trade bloc.
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