Question

The following information is for all three questions. Suppose the country of Coventry is joining a customs union (CU). It can buy Product S from the country of Plata or the country of Soyuz. Plata is not in the CU, while Soyuz is in the CU. Before joining the CU, Coventry has a tariff on all imports of Product S. After joining the CU, Coventry does not have a tariff on the Product S imported from other countries in the CU, but maintains its tariff on the Product S imported from countries outside the CU. The tariff, when applicable, is $7. (Use the Basic Tariff Model in this analysis and assume no foreign retaliation on this product.)

1. The price of Product S from Plata is $62 and the price of Product S from Soyuz is $65. Suppose Coventry changes from not being in the CU to being in the CU.

(a) Who is Coventry’s supplier of Product S before joining the CU? After joining the CU?

(b) Is there a trade creation effect in this case?

(c) Is there a trade diversion effect in this case? Why?

(d) What happens to the Coventry Total Surplus for Product S because it joined the CU? Why?

Answer 1

A) before joining the CU, the trading partner is Plata bcoz import price is lower at $62, then from Soyuz

After joining CU, trade takes place from Soyuz, bcoz no tariff from Soyuz ,& import price is $65, & import price from Plata is 62+7 =$69

Thus lower import price from Soyuz

B) yes trade creation effect , bcoz after joining CU, trade is created from Soyuz , which earlier wasn't there

C) yes trade diversion effect, bcoz now no trade from Plata, trade is diverted from Plata to Soyuz

D)total surplus rises, bcoz consumer surplus increases , as after trade price is $65

Before trade price is $62+$7 =$69

Thus lower price , but loss of tariff revenue,

But overall surplus rise.