We assume that there are three countries in the world: countries A, B and C. Each country has the supply and demand for a homogeneous good in the representative industry. Countries A and B will constitute a free trade area. (Note that trade diversion and creation can occur whether a preferential trade agreement, free trade area or customs union is established. For simplicity, we call the Free Trade Area Agreement [FTA].) The focus of this analysis will be on Land A, one of the two members of the FTA. We assume that country A is a small country in international markets, which means that it takes international prices as indicated. Countries B and C are considered large countries (or regions). Thus, country A can export or import as much of a product as with countries B and C, at any price in these markets. Therefore, the very nature of commercial creation lies in the elimination of tariffs at the internal border of states that have united (usually already with each other), which can lead to a further fall in the price of goods, while there may be a case of new trade flows creating goods between states that have decided to integrate economically.

In this section, we present an analysis of business reorientation and business creation. The analysis uses a partial equilibrium framework, which means that we take into account the impact of preferential trade liberalization on a representative industry. Later, in the section, we will examine how the results of representative industrial cases can be expanded to take into account trade liberalization, which covers all trade sectors. Where a customs union is established, Member States shall establish among themselves a free trade area and a common external law for third countries. As a result, Member States are forging greater trade relations with each other after the removal of protectionist barriers such as customs duties, import quotas, non-tariff barriers and subsidies. The result is an increase in trade between Member States for the good or service of each nation`s comparative advantage. In other words, increased trade generates higher (more profitable) incomes. The fear is that regional trade agreements will liberalise trade between their member states, but that they will also encourage agreements to put up protectionist barriers against countries outside the region. The logic here is that the larger the regional trading area in relation to the size of the global market, the greater the market power of this region will be in trade.

The higher the market power, the higher the region`s optimal tariffs and export taxes would be. Thus, the regional approach to trade liberalization could lead to the creation of large “trading blocs” that weigh freely between members, but stifle trade with the rest of the world. . . .