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On the Welfare Implications of Customs Unions in the Presence of Finance Constraints

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  • Theodore Palivos
  • Chong K. Yip

Abstract

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.

Suggested Citation

  • Theodore Palivos & Chong K. Yip, 2001. "On the Welfare Implications of Customs Unions in the Presence of Finance Constraints," Manchester School, University of Manchester, vol. 69(2), pages 164-178, March.
    • Handle: RePEc:bla:manchs:v:69:y:2001:i:2:p:164-178
    DOI: 10.1111/1467-9957.00240
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