Question

Preferential Trade Agreements. Consider Figure 1 below, where country A can import apples from two alternative sources, i.e. country C, the “low cost” supplier, or country B, the “high cost” supplier. Answer the following questions:

(a) Consider a situation in which country A applies a non-discriminatory import duty t to apple imports from all countries, and assume that the tariff is non prohibitive. From which country will A import? How many apples will be imported?

(b) Consider now an alternative scenario, in which country A maintains the initial tariff on imports from country C, but establishes a customs union with country B. From which country does A now import apples? Compare the outcome in the previous question with the current one. What are the welfare effects of establishing a customs union? Can we always conclude that the CU welfare dominates the situation with a non discriminatory tariff?

(c) State the Cooper–Massell proposition, and illustrate it in this context.

Figure 1: A Customs Union

Figure 1: A Customs Union Home (A) Demand Home (A) Supply PB PC

Answer 1

a) Country A will import apples from Country C as that country is a low cost supplier to Country C. If Country A is importing from Country B it has to pay high and also additional import duty which makes the apples even costlier. So country A imports apples from Country C.

B) The welfare effects of customs union is that they can have free trade with each other and maintain good relationship between countries. Even if they charge import duties the duty levied on imports will be lesser amount compared to other countries.

As Country B have custom union with Country A most of the apples imported to Country A will be from Country B.

In the previous case there is an same import duty on every country, so country A will import from a low cost supplier which is country C. Now as the customs union with Country B , the import levied on goods from country B will be less compared to Country C.So country A import from Country B.