Premium
On the Welfare Implications of Customs Unions in the Presence of Finance Constraints
Author(s) -
Palivos Theodore,
Yip Chong K.
Publication year - 2001
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/1467-9957.00240
Subject(s) - economics , monetization , welfare , tariff , constraint (computer aided design) , monetary economics , inflation (cosmology) , distortion (music) , macroeconomics , international economics , market economy , mechanical engineering , amplifier , physics , cmos , electronic engineering , theoretical physics , engineering
We examine the welfare effects of a customs union on a small monetary economy. The role of money is captured by a generalized cash‐in‐advance constraint which allows for non‐uniform monetization across sectors. This generates a demand‐side distortion which results in a discrepancy between the marginal domestic rate of substitution and the world price. We show that, depending on the economy’s inflation rate and the difference between the existing and the optimal tariff rate, trade creation may reduce welfare while trade diversion may improve it.