International Trade

INTERNATIONAL TRADE
QUESTION 1
a). Economic integration is an agreement among countries in a geographic region to reduce and
ultimately remove, tariff and non tariff barriers to the free flow of goods or services and factors
of production among each others; any type of arrangement in which countries agree to coordinate
their trade, fiscal, and/or monetary policies are referred to as economic integration. This is meant
in turn to lead to lower prices for distributors and consumers with the goal of increasing the level
of welfare, while leading to an increase of economic productivity of the countries.
b). Preferential trade arrangement: A trade pact between countries that reduces tariffs for
certain products to the countries who sign the agreement. While the tariffs are not necessarily
eliminated, they are lower than countries not party to the agreement. Example include the North
American Free Trade Agreement.
A free trade area: Geographical area formed by the national boundaries of two or more
countries belonging to a free trade agreement. Example is ASEAN Free Trade Area.
A custom union: A customs union is a type of free trade agreement (FTA) which involves the
removal of tariff barriers between members, together with the acceptance of a common (unified)
external tariff (CET) against non-members. Examples include European Union (EU), Customs
union of Russia, Belarus and Kazakhstan, which was formed in 2010.
A common market: Is an organization of countries who have agreed to trade freely with each

other and make common decisions about industry and agriculture. Examples include Mercosur
(Southern Cone Market), East African Common Market, and West African Common market and
COMESA.
An economic union is a type of trade bloc which is composed of a common market with

a customs union. The participant countries have both common policies on product
regulation, freedom of movement of goods, services and the factors of
production(capital and labour) and a common external trade policy. When an economic union
involves unifying currency it becomes an economic and monetary union. The European Union is
an example of an economic union. With one currency, they adopted one monetary policy
Duty free zone: Area where goods can be imported or exported without having
to pay the tax that would normally be charged: Tanger Free Zone in Morocco, Misrata Free
Trade Zone in Libya.
QUESTION 2
a) Difference between Trade creation and trade division
Trade creation is something in which trade flows increase due to the formation of a

free trade area or a customs union in which you exchange goods and services with other
and trade diversions is something that trade is diverted from a more efficient exporter towards a
less efficient one by the formation of a free trade.
b) YES. If Nation A imposes a 100 percent ad valorem tariff on imports of commodity X from
Nation B and Nation C, Nation A will produce commodity X domestically because the
domestic price of commodity X is K10 as compared with the tariff-inclusive price of K16 if
Nation A imported commodity X from Nation B and K12 if Nation A imported commodity
X from nation C.
ii). If Nation A forms a customs union with Nation B, Nation A will import commodity X from
Nation B at the price of K8 instead of producing it itself at K10 or importing it from Nation C at
the tariff-inclusive price of K12
iii). When Nation A forms a customs union with Nation B this would be a trade-creating customs
union because it replaces domestic production of commodity X at Px=K10 with tariff-free
imports of commodity X from Nation B at Px=K8
iv).
iv).
v). The welfare gains that Nation B receives from joining Nation A to form a customs union is
given by the sum of the areas of triangles CJM and BHN in Figure above .
c). Second-best theory, also known as the theory of the second best, is a concept in economics
that if a requirement for achieving an optimum economic situation is not satisfied, making a
concerted attempt to satisfy those requirements that can be met might not be the second-best
option, and may be harmful. In other words, if components of an economy is imperfect,
attempting to improve the seemingly ‘good’ ones can do more harm than good.
The study of customs union from the theoretical point of view is second best theory. Customs
unions are by definition discriminatory. They mean a lowering of tariffs within the union and an
establishing of a joint outer tariff wall. They combine free trade with protection. The basic model
of customs union is that of two commodities and three countries; the home country, the partner
country and the foreign country (the rest of the world). By assuming infinite elasticity of foreign
and partner supply and the non- existence of tariffs imposed by foreign and partner countries, it
can easily be shown that the welfare of the home country is increased by the trade creation effect
diminished by the trade diversion effect of the home country’s granting a discriminatory
elimination of its tariff on imports from the partner while retaining its tariff on those from the
foreign country.
REFERENCES
 Machlup, Fritz (1977). A History of Thought on Economic Integration. New York: Columbia
University Press. ISBN 0-231-04298-1.
 O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper
Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 157. ISBN 0-13-063085-3.
 Jump up^ Page 2, Balassa, Bela. The Theory of Economic Integration (Routledge Revivals).
Routledge, 2013.
 European Bank for Reconstruction and Development, Transition Report (London: EBRD,
2011).

International Trade

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INTERNATIONAL TRADE

A common market: Is an organization of countries who have agreed to trade freely with each

An economic union is a type of trade bloc which is composed of a common market with

a) Difference between Trade creation and trade division

Trade creation is something in which trade flows increase due to the formation of a

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