13.

The Effects of Economic Integration on Trade

Trade Static effects deal with snapshots immediately

Creation after integration.
Effect
Tariff preferences have trade creation effect and
trade diversion effect.

The two red traingles represent the positive

 welfare gains from the trade creation effect.

 Trade Three countries:

Diversio
n Effect (i) A, B are members of a CU
(ii) C is not
Assume (i) horizontal foreign supply curve
(ii) C (nonmember) is more efficient than B
(member)
Figure 4, Trade Diversion
Under the free trade situation, the England
imports the product from Australia.
After joining the customs union, the tariff
inclusive price of imports from Australia rises,
but the price of imports from France remains the
same. Accordingly,
England now imports from France, rather than
 from Australia.

 Dynamic include the response of the economy over time as

Effects it responds to the changes.

(i) Viner's analysis of CU focuses on static gains: the

Market abolition of tariffs among members has the trade
extension creation and diversion effects. However, the
static theory ignores the dynamic effects of CU
on economic growth.
(i) the most obvious dynamic consequence of a
CU is market extension. Efficient producers
enjoy free access to national markets of all
member countries. Obviously, inefficient
producers lose even the national market and are
forced to exit from the market.
Before forming a CU, however, access to foreign
markets was hindered or blocked by trade
restrictions. CU enables firms to achieve
economies of scale.
An efficient firm not only survives but also has
access to all markets within a customs union, but
inefficient firms lose even the little markets they
had before. (The Parable of Talents: For everyone
who has will be given more, and he will have an
abundance. Whoever does not have, even what he
 has will be taken from him, Matthew 25:29)
Figure 4.

  Domestic firms are no longer protected from high

tariffs. Increased competition implies the survival
(ii) of low cost firms and lower prices. Increased
Increased competition also encourages product innovation.
Competiti
on