A Customs Union with a Continuum of Products

This paper analyses the customs union problem in a model containing a continuum of products. The continuum is in three dimensions, so that three countries each have a distinct comparative advantage. Trade patterns are endogenously determined, and changed by policy. This is in the tradition of Viner, but in contrast to recent models in which the direction of trade is exogenously given. The effects of internal liberalization of trade patterns and consequent welfare effects through trade creation, diversion, and modification are established. Optimal policies are characterized, and sufficient conditions for tariff reform to raise welfare are found. Interactions between internal and external policy are analysed.