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Trade diversion in a preferential trade bloc occurs when:

Trade diversion occurs when a bloc's tariff preference shifts imports from a more efficient, lower-cost non-member to a less efficient, higher-cost member. It is a welfare-reducing effect, unlike trade creation, where imports move from costly domestic producers to cheaper member producers.

  1. AImports shift from a low-cost non-member to a higher-cost member because of the tariff preferenceCorrect
  2. BImports shift from a high-cost domestic producer to a lower-cost member
  3. CExports of members rise because of larger market size
  4. DMembers adopt a common currency to reduce costs

Explanation

Trade diversion means the tariff preference makes a less efficient member's goods cheaper than those of a more efficient outsider, so trade is redirected and efficiency falls. The second option describes trade creation, which is the opposite effect and a welfare gain.

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