Tariff

Figure 1. Canada, The United Stated of America and Mexico, the three countries that make up the NAFTA free trade area.

A tariff is a tax on goods and services imported into a country from another. An import tariff can be levied as either an ad valorem tax or a specific tax, either a percentage of the imported value or a set amount per unit. Tariffs are often used to limit trade between countries to stop the flow of goods from outside a country as they compete with those inside the country. The restriction of imports into a country restricts the supply to the market resulting in an increase in the price of the restricted good.

Free Trade

Trade agreements and economic unions such as the European Union (EU) or NAFTA (North American Free Trade Agreement) are designed to eliminate the barriers of trade that tariffs pose. By dropping the barriers between countries, trade becomes more efficient as the flow of goods and services can better stabilize markets in various countries. Trade agreements can be unilateral such as Canada's free trade agreement (FTA) with the EU. NAFTA is a FTA between Canada, Mexico and the United States, because all three countries are in close geographical proximity and have all signed the agreement, a free trade area is created. In a free trade area, the member countries agree on the goods and services to be traded freely but retain the ability to make agreements with other nations outside of the free trade area. Under these agreements the various nations agree to drop tariffs on specific goods and services or groups of goods and services such as agriculture products, livestock products or energy goods.