By joining the North American Free Trade Agreement, the United States, Canada, and Mexico would find their short-run welfare decreasing because of the a. economies of scale effect. b. trade creation effect. c. trade diversion effect. d. business investment effect.

Answer: C. Trade diversion

Explanation: The North America Free Trade Agreement (NAFTA) regression to a trade deal between The United States, Canada and Mexico which is aimed at enhancing economic integration between the member states. The agreement would mean that member states trade with one another through import and export trade business, with member companies serving as market for products produced by partner companies at reduced cost and elimination of tariff. Despite the benefits, trading nations witness decrease in short-run welfare due to trade diversion caused by reduction in revenue due to tariff elimination, job loss due to reduction in cost of export.

c. trade diversion effect.

Explanation:

Trade diversion is an economic situation in which countries import their goods from a particular country, often times (less efficient exporter), instead from the more efficient exporter due to formation of free trade agreements between or among the countries involved.

However, while at superficial level, the exporting country will export more of their goods, and the consumers from importing contry will have the price of the goods reduced due to formation of free trade agreement between the countries. The countries would find their short run welfare decreasing due to following reasons:

1. Exporting countries will suffer loss due to reduction in prices of their goods, which will in turn cause reduction in production output, thus, employment level will reduce or mass loss of jobs, reduction in profits, and decrease in payments to fixed cost.

2. Government of importing countries, will lose the money or revenue they normally gain from import tariffs, thereby decreasing the government spending on the economy, which will outrightly have negative effects.