A) If Nation a Subsequently Forms a Customs Union with Nation B, Will Nation a Produce

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Suppose that the autarky price of commodity X is $10 in Nation A, $8 in Nation B and $6 in Nation C, and Nation A is too small to affect prices in Nation B or C by trading. Nation A initially imposes a nondiscriminatory ad valorem tariff of 100 per cent on its imports of commodity X from Nations B and C. (a) If Nation A subsequently forms a customs union with Nation B, will Nation A produce commodity X domestically or import it from Nation B or Nation C? Answer: If Nation A forms a customs union with Nation B, Nation A will import commodity X from Nation B at the price of $8 instead of producing it itself at $10 or importing it from Nation C at the tariff-inclusive priceof $12. (b)Will this customs union lead to any trade diversion? Why? Answer: The formation by Nation A of a customs union with Nation B leads to trade creation only because Nation A replaces the domestic production of commodity X at Px=$10 with tariff-free imports of commodity X from Nation B at Px=$8.

Question 4 Suppose that the autarky price of commodity X is $10 in Nation A, $8 in Nation B and $6 in Nation C, and Nation A is too small to affect prices in Nation B or C by trading. Nation A initially imposes a nondiscriminatory ad valorem tariff of 50 per cent (rather than 100 per cent) on its imports of commodity X from Nations B and C. (a) If Nation A subsequently forms a customs union with Nation B, will Nation A produce commodity X domestically or import it from Nation B or Nation C? Answer: If Nation A forms a customs union with Nation B, Nation A will import commodity X from Nation B at the price of $8 instead of importing it from Nation C at the tariff-inclusive price of $9. (b) Will this customs union lead to any trade diversion?

Answer: The formation by Nation A of a customs union with Nation B leads not only to trade creation but also to trade diversion because it replaces lower-cost imports of commodity X of $6 (from the point of view of Nation A as a whole) with higher priced...
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