Question

When the United States, Canada, and Mexico form a free trade area, and Mexico begins importing a product from Canada rather than from the lowest cost world producer.

A)	World welfare falls to zero

B)	World welfare rises

C)	Trade creation occurs

D)	Trade diversion occurs

Answer 1

It has been provided that when the United States, Canada, and Mexico form a free trade area, Mexico begins importing a product from Canada rather than from the lowest cost world producer.

When a country after formation of free trade area with another country starts importing a good from that country instead of from the efficient producer from the rest of the world then such action is referred to as trade diversion.

So, action of Mexico indicates trade diversion.

Hence, the correct answer is the option (D).