Suppose Canada has a 20% tariff on the import of carpets,and Canada currently imports this product from India at a with- tariff price of $22.The with- tariff price of identical carpets from the United States is $24.Now suppose a free- trade agreement with the U.S.eliminates the tariff and so the no- tariff price from the U.S.is $20.Canada now purchases carpets from the U.S.This is an example of

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Trade diversion occurs when a country imports a good from a higher-cost producer after the elimination of a tariff or other trade barrier. In this case, Canada was importing carpets from India at a with-tariff price of $22. After the free-trade agreement with the U.S., the no-tariff price from the U.S. is $20, which is lower than the with-tariff price from India. As a result, Canada now purchases carpets from the U.S., even though the U.S. is a higher-cost producer. This is an example of trade diversion.

Suppose Canada Has a 20% Tariff on the Import of Carpets,and