Tariffs, Import Quotas, and Customs Unions

By Yeh, Yeong-Her | Atlantic Economic Journal, December 1992 | Go to article overview

Tariffs, Import Quotas, and Customs Unions


Yeh, Yeong-Her, Atlantic Economic Journal


The differences between tariffs and import quotas in their economic effects have been extensively discussed the literature |Bhagwati and Srinivasan, 1983; Marksen and Melvin, 1988~. The purpose of this paper is to demonstrate another difference between them. It has been known that the welfare of a tariff-imposing country could increase, decrease, or remain the same after it joins a customs union. The outcome depends on the welfare-reducing trade diversion effect and welfare-improving trade creation effect of the customs union |Bhagwati, 1971; Chacholiades, 1990; Lipsey, 1960~. It will be shown in this paper that the welfare of a quota-imposing country will always increase after it joins a customs union. The partial equilibrium approach is used in this study. It is assumed that there are no inferior goods.

In Figure I, D and S denote the demand curve and supply curve of the home country A, respectively. |OP.sub.B~ and |OP.sub.C~ measure the prices of good X in foreign countries B and C, respectively. |OP.sub.B~ and |OP.sub.C~ remain constant under the assumption that country A is a small country. Suppose that country A imposes a tariff before it forms a customs union with country B. Since |OP.sub.C~ is less than |OP.sub.B~, country A would import good X from country C. The domestic price of good X is equal to |Mathematical Expression Omitted~, which is greater than |OP.sub.C~ by the full amount of the tariff, t. The amount of imports is equal to ad and the tariff revenue is measured by amnd.

Next, suppose that country A and country B form a customs union. Country A's tariff on imports from country B will be eliminated. However, the same tariff, t, is still imposed on imports from country C after the customs union. After the customs union, the domestic price of good X is equal to |OP.sub.B~ and country A would import bf of good X from country B.

The effects of the customs union on country A's welfare can be shown as follows. The consumer surplus is increased by |Mathematical Expression Omitted~. However, the producer surplus is decreased by |Mathematical Expression Omitted~, and the tariff revenue is reduced by amnd. The welfare of country A could increase, decrease, or remain the same after the customs union, depending on whether (abc + def) is greater than, less than, or equal to cmne, respectively. (abc + def) measures the welfare-improving trade creation effect, whereas cmne measures the welfare-reducing trade diversion effect of the customs union.(1)

Now consider the case where country A imposes an import quota instead of a tariff before it forms a customs union with country B. Suppose that the import quota(2) is equal to ad, the amount of imports under the tariff. Country A will import ad of good X from country C. The domestic price of good X in country A is equal |Mathematical Expression Omitted~ and amnd measures the import quota revenue. …

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