Universidad Carlos III de Madrid – Economics of European

Universidad Carlos III de Madrid – Economics of European Integration
Problem Set 2: Customs Unions
TA: Josef Ruzicka
Fall 2016
Under trade creation we understand a replacement of domestic production by cheaper imports. Trade
diversion arises when imports from one country are replaced by more expensive imports from another country.
Problem 1
Suppose prices of corn and import tariffs in a group of central American countries are given by the table
below. Both prices and tariffs are expressed in monetary units per unit of corn.
Country
Price
Tariff
70
40
Guatemala
110
30
Honduras
140
10
90
40
Nicaragua
120
60
Costa Rica
80
20
Belize
El Salvador
1. What is the price of corn produced in Costa Rica, when sold in Belize?
(a) 80
(b) 120
(c) 110
(d) 70
2. What is cheaper in Guatemala: domestic production, or imports?
(a) Domestic corn
(b) Imported corn
(c) They both cost 100.
(d) They both cost 110.
3. Which countries import corn?
(a) Guatemala
(b) Guatemala and El Salvador
(c) Guatemala and Honduras
(d) Guatemala, Honduras, El Salvador and Nicaragua
4. Which countries export corn?
(a) Belize
(b) Costa Rica
(c) Belize and Costa Rica
(d) Belize, Costa Rica and El Salvador
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5. Suppose that El Salvador, Nicaragua and Costa Rica form a free trade area. Which countries import
corn?
(a) Guatemala
(b) Guatemala and El Salvador
(c) Honduras, El Salvador and Nicaragua
(d) Guatemala, Honduras, El Salvador and Nicaragua
6. Which countries export corn?
(a) Belize
(b) Costa Rica
(c) Belize and Costa Rica
(d) Belize, Costa Rica and El Salvador
7. What are the effects of the free trade area?
(a) Trade creation
(b) Trade diversion
(c) Both trade creation and trade diversion
(d) Neither trade creation nor trade diversion
8. In addition, suppose that Guatemala and Honduras form a customs union with a common external tariff
of 50. Which countries import corn?
(a) Guatemala
(b) Guatemala and El Salvador
(c) Honduras, El Salvador and Nicaragua
(d) Guatemala, Honduras, El Salvador and Nicaragua
9. Which countries export corn?
(a) Belize
(b) Nicaragua
(c) Guatemala and Costa Rica
(d) Guatemala, Costa Rica and El Salvador
10. What are the effects of the customs union, relative to the situation in question 5?
(a) Trade creation
(b) Trade diversion
(c) Both trade creation and trade diversion
(d) Neither trade creation nor trade diversion
11. Finally, suppose locusts damage the crops in Belize, driving up the price of corn there to 140. Consequently, Belize decides to join the free trade area of El Salvador, Nicaragua and Costa Rica. What does
the enlargement of the free trade area give rise to?
(a) Trade creation
(b) Trade diversion
(c) Both trade creation and trade diversion
(d) Neither trade creation nor trade diversion
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Problem 2
Suppose Argentina and Chile are too small to influence the world price of oats, PW = 0.5, which they take
as given. Denote demand and supply of oats in Argentina DA and SA , respectively. Denote DC and SC
demand and supply of oats in Chile. They take the following form:
DA = 400 − 200P
DC = 200 − 100P
(1)
SA = −100 + 200P
SC = −200 + 400P
(2)
Suppose Argentina and Chile initially form a customs union with a common external tariff of 0.25.
12. What is the tariff revenue in Argentina and Chile?
(a) 0 in Argentina, 0 in Chile
(b) 50 in Argentina, 6.25 in Chile
(c) 100 in Argentina, 12.5 in Chile
(d) 50 in Argentina, 12.5 in Chile
13. What is the total surplus in Argentina and Chile?
(a) 112.5 in Argentina, 84.375 in Chile
(b) 162.5 in Argentina, 84.275 in Chile
(c) 162.5 in Argentina, 90.625 in Chile
(d) 212.5 in Argentina, 96.875 in Chile
14. Suppose Argentina and Chile decide to protect local production even more by raising the tariff to 0.75.
What is the tariff revenue in Argentina and Chile?
(a) 0 in Argentina, 0 in Chile
(b) 50 in Argentina, 6.25 in Chile
(c) 100 in Argentina, 12.5 in Chile
(d) 150 in Argentina, 18.75 in Chile
15. What is the total surplus in Argentina and Chile?
(a) 150 in Argentina, 100 in Chile
(b) 112.5 in Argentina, 90 in Chile
(c) 125 in Argentina, 25 in Chile
(d) 62.5 in Argentina, 50 in Chile
16. What are the welfare effects of the higher common external tariff?
(a) Both Argentina and Chile are better off
(b) Argentina is better off, Chile is worse off
(c) Argentina is worse off, Chile is better off
(d) Both Argentina and Chile are worse off
17. What are the trade effects of the higher common external tariff?
(a) Trade creation
(b) Trade diversion
(c) Both trade creation and trade diversion
(d) Neither trade creation nor trade diversion
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18. Suppose the customs union breaks up. Argentina and Chile both keep the tariff at 0.75. What is the
tariff revenue in Argentina and Chile?
(a) 0 in Argentina, 0 in Chile
(b) 50 in Argentina, 6.25 in Chile
(c) 100 in Argentina, 12.5 in Chile
(d) 150 in Argentina, 18.75 in Chile
19. What is the total surplus in Argentina and Chile?
(a) 150 in Argentina, 100 in Chile
(b) 112.5 in Argentina, 90 in Chile
(c) 125 in Argentina, 25 in Chile
(d) 62.5 in Argentina, 50 in Chile
20. What are the welfare effects of disintegration of the customs union?
(a) Both Argentina and Chile are better off
(b) Argentina is better off, Chile is worse off
(c) Argentina is worse off, Chile is better off
(d) Both Argentina and Chile are worse off
21. What are the trade effects of disintegration of the customs union?
(a) Trade creation
(b) Trade diversion
(c) Both trade creation and trade diversion
(d) Neither trade creation nor trade diversion
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