ChainWhat it assumes · how to break it
Start
A country joins a customs union, removing tariffs on trade with member states and charging a common external tariff on imports from the rest of the world, as members of the EU customs union do.
1
As a result, tariffs on imports from member countries are removed, so the price of those goods falls.
trade creation
trade creation
Assumes: Firms pass the tariff cut on to buyers.
But: Retailers with market power may keep part of the tariff cut as profit.
2
This means consumers pay less for goods from members, and firms buy inputs from members more cheaply, shifting SRAS to the right.
SRAS · costs of production
SRAS · costs of production
Assumes: A large share of imports and inputs comes from members.
But: If most imports come from outside the bloc, the fall in costs is small.
3
At the same time, the common external tariff applies to imports from outside the bloc, replacing the country's own tariffs.
common external tariff · trade diversion
common external tariff · trade diversion
Best link to attack
Assumes: The common external tariff is no higher than the country's old tariffs.
Assumes: The common external tariff is no higher than the country's old tariffs.
But: A country that had low tariffs on goods such as food before joining may face higher prices on imports from outside the bloc after adopting the common external tariff.
4
Therefore, if trade creation outweighs the effect of higher external tariffs, the price level falls and inflation is lower for a time.
price level · cost-push inflation
price level · cost-push inflation
Assumes: Cheaper member imports outweigh dearer non-member imports.
But: Trade diversion to higher-cost members means some goods cost more than they would under free trade with the world.
End
Cheaper imports from members lower the price level, though higher external tariffs can offset this for some goods.
Evaluation chain
- E1However, the effect on prices depends on how the common external tariff compares with the tariffs the country charged before.
- E2If the country previously had low tariffs on goods it imports mainly from outside the bloc, adopting the common external tariff raises their prices.
- E3As a result, consumers pay more for those goods, and trade diverts to higher-cost member suppliers.
- E4So joining a bloc lowers inflation for a country that had high tariffs before, but may raise prices of some goods for a country that had low tariffs.
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Questions this answers
- Assess the impact of joining a customs union on the rate of inflation.
- Discuss whether consumers gain from membership of a trading bloc.
- Explain how a common external tariff can raise prices.
Diagram
Customs union diagram showing the import price falling from the world price plus tariff to the partner's price; or AD/AS with SRAS shifting right.
Reverse and related
Leaving a customs union → tariffs on goods from former members raise import prices and costs, adding to inflation.