Lecture 3 - Are customs unions good or bad for the economy

Lecture objectives
What are the characteristics of the ideal partner, to form a CU/FTA?

Partial equilibrium model
Assumptions

  • One market, homogeneous goods. Partial equilibrium to ignore knock on effects of changes

  • Perfect competition

    • Knowledge is perfect
    • Many firms in the market
    • Supply curve is upwards sloping due to increasing costs, increases when price increases
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      Implications: Consumers and producers are price takers

  • Luxembourg is relatively small compared to the big boys, US, China, India.

  • This means that they have to sell at the price due to competition.

  • The domestic consumers in Luxembourg are small quantity, hence they have no bargaining power in the market

  • Therefore is completely elastic, i.e perfectly horizontal

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The assumptions of the model continued:

  • Partial equilibrium; ignoring impact to other markets
  • World of three countries
    • Home country is small
    • Future partner is large - perfectly elastic supply
    • ROW is also large, lower supply price than partner