Suppose that Canada has domestic firms that could supply its entire market for radios at a price of $50, while U.S.firms could supply radios at $40 and Mexico at $30.Suppose that Canada initially has a 50 percent tariff on imports of radios and then forms a free trade area with the United States.As a result, Canada realizes

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Canada experiences trade diversion because it shifts from importing cheaper radios from Mexico to more expensive ones from the U.S. due to the free trade area. However, there is also trade creation as Canada imports from the U.S. instead of producing domestically. The overall welfare impact depends on the balance between these effects.

Suppose That Canada Has Domestic Firms That Could Supply Its