Product market imperfections and customs unions theory

The purpose of this paper is to analyze the welfare implications of trade creation and trade diversion within the context of the standard model of customs unions to which increasing returns and domestic monopoly have been added. The problem we consider is particularly important to the less-developed countries in which both types of product market imperfections are encountered. It is shown that, in the presence of product market imperfections, trade creation I and trade creation II may entail welfare loss, while trade diversion I and trade diversion II may be welfare-improving.