Question 54

Trade diversion leads to increased production costs within a trading bloc.

Trade diversion often results in the allocation of resources to less efficient producers within a trading bloc, leading to higher production costs.

A) Efficiency increases.

This option is incorrect because trade diversion typically reallocates resources to less efficient producers. Instead of optimizing production based on comparative advantage, resources may be diverted to producers who are not the most efficient, resulting in a decrease in overall efficiency.

B) Prices decrease.

This option is also incorrect. While trade liberalization can lead to lower prices due to increased competition, trade diversion may lead to higher prices if resources are allocated to less efficient producers within the bloc, negating the benefits of lower costs associated with more competitive external producers.

C) Costs increase.

This is the correct option. Trade diversion causes producers within a trading bloc to source inputs or produce goods from less efficient sources, which increases production costs compared to a scenario where trade occurred with the most efficient global producers.

D) Wages decrease.

This option is incorrect as well. While increased production costs can lead to pressure on profits, wage levels are influenced by many factors, and trade diversion does not necessarily lead to direct wage decreases. Wages may remain stable or even increase if productivity gains can be achieved despite higher costs.

Conclusion

In summary, trade diversion primarily leads to an increase in production costs due to the shift towards less efficient producers within a trading bloc. This results in a negative impact on overall production efficiency, contrasting with the potential benefits of trade if it were conducted with the most efficient global producers. Other options do not accurately reflect the implications of trade diversion on production costs and efficiency.