(Table: U.S. Demand for and Supply of Widgets) The United States can import widgets from China at $4 each and from Mexico at $5 each. The United States imposes a tariff of $2 on each of its widget imports. Suppose that the United States and Mexico form a free-trade area. How much trade in widgets is diverted in the U.S.-Mexican free-trade area?

Question

Quizplus · Accepted Answer

Without the free-trade area, the U.S. would be importing widgets from China for $4 + $2 tariff = $6 and potentially importing from Mexico for $5 + $2 tariff = $7. Therefore, it would make sense for the U.S. to import from China. 
However, with the free-trade area, there would be no tariff on imports from Mexico, so the U.S. would import from Mexico for $5, which is cheaper than importing from China for $6. Therefore, the U.S. would divert trade from China to Mexico for a difference of $1 per widget. 
Assuming the U.S. initially imported x widgets from China, the amount of trade diverted would be the difference in the prices ($6 - $5) multiplied by the quantity x, or $1x. Therefore, the answer is C, 4 widgets.

(Table: US