More on Tariffs, Import Quotas, and Customs Unions

By Yeh, Yeong-Her | Atlantic Economic Journal, June 1996 | Go to article overview
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More on Tariffs, Import Quotas, and Customs Unions


Yeh, Yeong-Her, Atlantic Economic Journal


The welfare of a tariff-imposing country could increase, decrease, or remain the same after it joins a customs union. If the country concerned is a small country, the outcome depends on the welfare-reducing trade diversion effect and welfare-improving trade creation effect of the customs union. In the large country case, the outcome also depends on the terms-of-trade effects of the customs of union [Bhagwati, 1971; Lipsey, 1960]. The welfare of a small, quota-imposing country will always increase after it joins a customs union [Yeh, 1992]. The purpose of this paper is to show that the welfare of a large, quota-imposing country could increase, decrease, or remain the same after it joins a customs union.

The offer curve approach [Meade, 1952] will be used in this study. This paper is divided into two sections. Section I discusses the case in which the country concerned is a small country. Then Section II deals with the case in which the country concerned is a large country.

I. Section I

In Figure I, the vertical axis and horizontal axis measure the importable good Y and exportable good X of the home country A, respectively. OA is the offer curve of country A. OD and OU are the offer curves of foreign countries D and U, respectively. OD and OU are straight lines under the assumption that country A is a small country. OD is steeper than OU because the relative price of good Y in country U is assumed to be higher than that in country D. Point C will be the trading point under free trade.

Suppose that country A imposes a tariff. OA[prime] is the tariff-distorted offer curve of country A which intersects OD at E. Point E is the trading point after the tariff. Country A would import OG of good Y from country D. The domestic price ratio is measured by the slope of the trade indifference curve I at E or by line OE[prime].

Next suppose that country A forms a customs union with country U. While country A's tariff on imports from country U is eliminated, country A still imposes the same tariff on imports from country D. OA intersects OU at H. Point H will be the trading point after the custom union.(1) The domestic price ratio after the custom union is measured by line OU. Country A will import HH[prime] of good Y from country U. The welfare of country A could increase, decrease, or remain the same after the customs union. Figure I shows the case in which the welfare of country A is decreased after the customs union.(2) Country A reaches a lower trade indifference curve [I.sub.t] after the customs union than the trade indifference curve I before the customs union.

Now examine the case in which country A imposes an import quota instead of a tariff. Suppose that country A initially imposes an import quota equal to OG of good Y, which is the amount of imports under the tariff. The offer curve of country A after the import quota is OMG, which intersects OD at E. E is the trading point before the customs union. Country A will import OG of good Y from country D and the domestic price ratio is measured by the slope of the trade indifference curve I at E or by line OE[prime].(3)

Next suppose country A forms a customs union with country U. While country A's import quota on imports from country U is eliminated, the same import quota (OG of good Y) is still imposed on imports from country D. Draw country A's offer curve [Mathematical Expression Omitted] with point E as the origin. Then draw country U's price line [Mathematical Expression Omitted], which is parallel to line OU. Line [Mathematical Expression Omitted] intersects the offer curve [Mathematical Expression Omitted] at K. Point K will be the trading point after the customs union. The domestic price ratio after the customs union is measured by line [Mathematical Expression Omitted].

Country A's total amount of exports is equal to KK[prime] of good X and its total amount of imports is equal to OK[prime] of good Y. However, only GK[prime] of good Y is imported from country U.

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