Define and illustrate a welfare-reducing trade diversion effect of a customs union.

Expert Solution

Custom union tends to make import from non-member countries expensive. All members countries tend to impose similar tariffs on non-member countries. So, price will rise significantly if member country will go for import from non-member country. Thus, country has to shift its trade from low cost country to high cost member country. There are no tariffs among the member countries.

Member country will be benefited but overall world welfare will be compromised.

following diagram:

In above diagram, custom union will cause price movement from P1 to P2 when trade diversion occurs, while non member country price is above member country when tariffs are imposed. So trade divert now to member country which is expensive.

Rahul Sunny answered 1 year ago

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