Question

most customs unions or free trade agreements are created between countries of close geographical proximity. Why is this case? is this always welfare increasing? why or why not?

Answer 1

Custom union or trade agreements are negotiated to increase trade and commerce by dismantling trade barriers. Usually, these agreements are negotiated with countries of close proximity. Following are reasons responsible for such instances:

• Cost of negotiating such agreements is significantly low if countries are immediate neighbors.
• Further, these agreements can be enhanced further, if countries are close by. There might be a free flow of human resources easily across the countries.
• It also secures the borders politically, so the relationships among the members get improved significantly.

Generally, it has been seen that such trade negotiations raise the living standard of people. Free flow of goods and services reduces the price level and more goods and services get produced. Consumer surplus is increased massively. though welfare rises, side by side, there are instances where crisis might result. Crisis in the European Union is an illustration of such a crisis. Few members countries even facing a huge slump in output since these countries can not use their fiscal and monetary policies prudently and appropriately. Further, more developed and technologically active countries are able to corner a larger share of such free trade.