Explain the static effects and dynamic effects of economic integration. What is the difference between trade creation and trade diversion resulting from economic integration?
Answer: Static effects are the shifting of resources from inefficient to efficient companies as trade barriers fall. Dynamic effects are the overall growth in the market and the impact on a company of expanding production and achieving greater economies of scale. Static effects may develop when either of two conditions occurs:
a. Trade creation: Production shifts to more efficient producers for reasons of comparative advantage, allowing consumers access to more goods at a lower price than would have been possible without integration.
b. Trade diversion: Trade shifts to countries in the group at the expense of trade with countries not in the group, even though the nonmember company might be more efficient in the absence of trade barriers.
Dynamic effects of integration occur when trade barriers come down and the size of the market increases, allowing companies to achieve economies of scale.