The main purpose of competition policy is generally seen as protecting the market

mechanism from breaking down (El-Agraa, 2011). As with every policy there are arguments
and counter agreements. The balancing out of arguments pro and con has found its best
expression in a school of thinking that advocates the workable competition concept
(Molle, 2006). Stronger competitive pressures in customs union like the EU results in a
reduction in misallocations resulting from static inefficiency in resource allocation, reduced
technical efficiency and dynamic inefficiency (Molle, 2006) due to competition. Therefore,
there are similar effects between the removal of competition barriers and the removal of
barriers to trade. The technical and dynamic efficiency effects are far more important than
the static ones (Molle, 2006). This can be shown in Figure 1:

DG SG
Price

V R U
Pw+t3
SCU

Pw+t2 W
K L M N

WI Kl Ll Lll Nl
Pw+t1
Ml
G Sw
Pw
X H Hl I J

Al A B C D E El
Quantity
Figure 1: Effects of tariffs and improved technical efficiency

The first step it to look at the effects of trade and welfare which show in the Figure 1, which
reproduces the market for good x in country A - lets assume this country is Germany
whereby supply and demand are represented by SG and DG. Supply for the world (Sw) is fully
elastic. A change in supply from country B - lets called it France occurred; it is not
represented by curve SF, but combined with SG and incorporated with SCU, which represents
the entire customs union. The tariff t2 is just enough to avoid any imports from the world market
(SCU intersects N). Before the formation of the EU, Germany operated at tariff t3. After the
formation of the custom union the shared external tariff will drop to t2 and a further drop to t1
is desired. The static effects of this custom union is the decrease of tariff (from t3 to t2) resulting
in Germans total demand to be satisfied by the custom union. This in turn results to a trade-
creation effect (KRL) and a trade-expansion effect (MUN), against a trade-diversion effect
(HLMI). The area KRL and MUN is equal, therefore this custom union would be about welfare-
neutral. However, reducing the tariff to t1 would result in an import quantity AlC from the
partner country and CEl from the would create more welfare as KlRLl and MlUNl is a bigger
area than XKlLllHl.
 Price S1CU

S2CU
E F
Pw+t3 SW3
D G I
Pw+t2 K SW1
C
H
Pw SW

A B
Quantity

Figure 2: Advantage of improved efficiency

Manufacturers in Germany find themselves confronted by a loss in sales market (from OB to OA l

shown in Figure 1) , rather than accept the loss will accomplish savings on production costs. As a
result, the supply of Germany will move and down and the supply curve of the custom union will
experience a downward shift (S1CU to S2CU). Supply has dropped enough to permit the EU producers
to satisfy total home demand in the EU under a tariff protection of t1. The effects of the production
and consumption of this drop in cost is shown by the shift in equilibrium from F to I. The change in
welfare effects is shown by the change in cost of production of the initial quantity from OE to OD that
producers have realised under the stronger competitive pressures. The reduction of cost is equal to
DEFG. This is a net positive effect and not a redistribution effect of DEFK and a new effect of KFG.