Suppose country X currently produces widgets. Then it establishes a preferential trading agreement with country Y. Following the formation of the PTA, country X no longer produces widgets and imports widgets from country Y. What has occurred?
a. There is trade diversion and a welfare gain for both country X and country Y.
b. There is trade diversion, a welfare gain for country Y, and a welfare loss for country X.
c. There is trade creation and a welfare gain for both country X and country Y.
d. There is trade creation, a welfare gain for country Y, and a welfare loss for country X.
Ans: c. There is trade creation and a welfare gain for both country X and country Y.
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