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POSSIBLE GAINS FROM THE FORMATION OF A CUSTOMS UNION

POSSIBLE GAINS FROM THE FORMATION OF A CUSTOMS UNION. Reasons for the formation of Customs Union. Static gains: Better allocation of resources Dynamic gains: Economies of scale etc. Protectionism Economic integration is a prerequisite for political integration. Static Gains.

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POSSIBLE GAINS FROM THE FORMATION OF A CUSTOMS UNION

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  1. POSSIBLE GAINS FROM THE FORMATION OF A CUSTOMS UNION

  2. Reasons for the formation of Customs Union • Static gains: Better allocation of resources • Dynamic gains: Economies of scale etc. • Protectionism • Economic integration is a prerequisite for political integration

  3. Static Gains • Trade creation - Trade diversion • Hard to measure: • Economic growth • Other factors affecting trade other than CU

  4. Static Gains: Measurement of TC and TD • Standart Approach Net TC = Total increase in imports by Home country – the fall in imports from non-members caused by integration • Difficulties: • Trade figures are expressed in money terms, so it also shows the effects of relative prices • Non-integration influences must be excluded • Choice of dates for comparison (must allow some time)

  5. Static Gains: Measurement of TC and TD • Another Approach TC= Change in total imports / consumption TD= Change in imports from non-members / consumption (Between two years before and after integration)

  6. Static Gains: Measurement of TC and TD • Balassa, 1967: • Income elasticities of import demand= M • M = Average annual change in imports Average annual change in GNP • If M from intra-area   Gross trade creation • If M from all sources   Trade creation • If M from extra-area   Trade diversion

  7. Dynamic Gains • Improved terms of trade with the rest of the world • If the formation of the CU does not affect the demand for imports from the rest of the world, the union’s TOT will be unaffected. Otherwise, there will be a tendency for TOT to improve. • Increased capital inflows and increased rate of technological change (increases in quantity and quality of factor inputs) • Reduced uncertainty

  8. Dynamic Gains • Increased competition among firms within the CU (which increases efficiency) • Economies external to the firm which may have a downward influence on both general and specific cost structures

  9. Dynamic Gains • Better allocation of economies of scale for both firms and industries operating below optimum capacity before the integration occurs • Assumptions: • Domestic price=cost of imports from W+tariff • Homogenous product • W produces and supplies to H and P a constant prices • H and P is capable of producing at declining average costs

  10. Dynamic Gains • Pre-union possibilities: • Production in both H and P • Production in one country • Production in neither

  11. RISKS • Possible responses by firms in third countries who lose market share as a result of the CU and may seek to fight back.

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