Question

In 1992, Association of Southeast Asian Nations Free Trade Area (AFTA) was applied by eliminating tariffs and non-tariff barriers between the member countries. The original members were Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. knowing that:

• Brunei needs to import Cereal (Cereal is a homogenous good).
• The best exporter for Cereal that is United States (the price per ton is $8).
• Brunei can import Cereal from Indonesia (the price per ton is $12).
• Brunei imposed a specific tariff on its imports of Cereal accounts for $6 per ton.

Q1: Discuss the impacts of joining AFTA including Brunei and Indonesia on the foreign trade of both of Brunei, Indonesia and USA.

Q2: Will your answer be affected in the following cases?

1. If the price of Cereal in United States is $5 per ton instead of $8.

2. If Brunei is a small importer of cereal in one case and a large importer of cereal in another.

Answer 1

Q1. Since Brunei is a part of AFTA along with Indonesia, it will impose no tariff on the import of cereal from Indonesia. On the other hand, since it has no such agreement with the US, it will impose the $6 per ton tariff on any cereal impost from the US. In this case, there is a trade diverting union that has formed. In the absence of the AFTA, Brunei would import the cereal from the US, as it would be cheaper for Brunei. US cereal would cost Brunei $8 + $6 = $14 per ton and Indonesia cereal would cost Brunei $12 + $6 = $18. Hence, Brunei would import from the US. Now, with the free trage agreement with indonesia, Indonesia cereal costs only $12 for Brunei and US cereal would cost $14. Hence, it would import from Indonesia. This means that this trade agreement would cause loss of welfare for Brunei and for the US, and it would be beneficial for Indonesia.

Q2. If the United States cereal price is $5, then the after tariff import price of the US cereal for Brunei will be $5 + $6 = $11 which is till cheaper than no tariff indonesia cereal price, and hence there would be no welfare loss for anyone as Brunei would keep importing from the US even after the trade agreement was put in place.

If Brunei is a small importer of cereal, then the naswer would remain the same as then Brueni would be in no position to influence the price of cereal in any country. But if it is a large importer of cereal, then the loss of welfare for the US would be much more, and if Brunei is able to excert its influence on the cereal price of Indonesia, then the indonesia cereal price would be lowered to the point that Brunei does not have to suffer massive welfare losses as a result of being a part of the union.