Customs Union
What is Customs Union?
A customs union is a trade bloc whose members remove tariffs on trade with each other and also apply one common external tariff to non-members.
Calculate it: How to Calculate the Net Welfare Effect of a Customs Union
The common external tariff is what separates a customs union from a free trade area. In a free trade area each member keeps its own tariff schedule for outsiders, so goods need rules-of-origin paperwork to stop imports slipping in through whichever member charges the least. A customs union charges every outsider the same rate at any member's border, so that paperwork disappears and members must bargain with outsiders as a single group. It does not free the movement of workers or capital; adding that step gives a common market. Mercosur in South America is the usual example, though its common tariff carries a long list of exceptions.
Customs Union: a worked example
Country A buys shirts from abroad and charges a 50 percent tariff on all imports. Partner country B makes shirts for $20 and non-member C makes them for $16, so with the tariff they land at $30 and $24 and A buys from C. A then forms a customs union with B, so B's shirts enter free at $20 while C's still land at $24. Buyers switch to B and save $4 a shirt, but the government gives up the $8 of tariff revenue it collected on each shirt from C, a net loss of $4 a shirt. That switch to the higher-cost producer is called trade diversion.
The mistake students make with customs union
The usual error is calling any group that scraps internal tariffs a customs union. Scrapping internal tariffs alone makes a free trade area; the union is defined by the single external tariff every member charges outsiders. The second error is assuming a customs union lets people and money move freely across member borders. It does not, and that step belongs to a common market.
Customs Union questions
What is the difference between a free trade area and a customs union?
A customs union adds a common external tariff, which a free trade area does not have. Members of a free trade area drop tariffs on each other but each sets its own rate for outside countries, so imports need rules-of-origin checks. Customs union members charge outsiders the same rate and negotiate with them as one bloc.
What is trade diversion?
Trade diversion is when a trade bloc shifts imports from a cheaper outside producer to a more expensive member producer, purely because the member's goods are now tariff-free. The buyer pays less, but the government loses more tariff revenue than the buyer saves. It is the main reason a customs union can leave a country worse off.
Is a customs union the same as a common market?
No, a common market goes one step further by adding free movement of labor and capital. A customs union covers goods only: no internal tariffs and one shared external tariff. A common market keeps both of those features and lets workers and investment cross member borders freely.
Formula / Example
Free trade at a world price below the domestic price: imports fill the gap. Tap it to drag the curves, open the full version, or put it on your own site free, or turn it into a five-minute class activity.
Related terms
Common comparisons
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated