Customs union theory reasons that the formation of a customs union will decrease members' real welfare when the
A) trade diversion effect exceeds the trade creation effect.
B) trade production effect exceeds the trade consumption effect.
C) trade consumption effect exceeds the trade production effect.
D) trade creation effect exceeds the trade diversion effect.

Question

Quizplus · Accepted Answer

According to the customs union theory, the trade diversion effect occurs when member countries switch from importing goods from a more efficient non-member country to importing goods from a less efficient member country due to the elimination of tariffs. The trade creation effect occurs when member countries increase trade with each other due to the elimination of tariffs. If the trade diversion effect exceeds the trade creation effect, then members' real welfare will decrease because they are now importing goods from less efficient sources, which will lead to higher prices for consumers and lower profits for producers. Hence, option A is the correct answer.

Customs Union Theory Reasons That the Formation of a Customs