The effects of customs unions on the pattern and terms of trade in a Ricardian model with a continuum of goods

This paper adapts the Dornbusch-Fischer-Samuelson continuum-of-goods Ricardian model to three countries. The pattern of trade and the terms of trade are determined endogenously in this general-equilibrium model. We derive comparative statics effects of endowment and tariff changes on trade patterns and terms of trade, and apply the results to customs union theory. Trade creation and trade diversion impacts of unions are shown to be determined by the position of countries' traded goods on the continuum. In addition, the desirability of economic integration is found to depend on the level of country development.