(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. Is the United States better off or worse off in its trade in widgets following the free-trade agreement with Mexico?

Question

Quizplus · Accepted Answer

The imposition of a tariff on imports makes trade with Mexico more expensive compared to trade with China. Therefore, the United States will likely shift some of its imports from China to Mexico, resulting in trade diversion. However, the cost of widgets from Mexico is higher than the cost of widgets from China, so the United States will experience a loss in terms of consumer surplus. Thus, the trade diversion losses exceed the trade creation gains, resulting in the United States being worse off in its trade in widgets following the free-trade agreement with Mexico.

(Table: US