A Pareto Improvement in Customs Unions Without Intra-Union Transfer

Kemp and Wan (1976) proved a theorem on the formation of customs unions: a common tariff vector can be found in the union such that there exists a Pareto improvement in the union without changing the international prices and the purchases from the rest of the world in the associated tariff-ridden competitive equilibrium. However, this Pareto-optimum may imply a tariff-ridden competitive equilibrium with an intra-union income transfer that does not seem to be very realistic.

We give a strictly analytical proof to show that under some conditions on the tariff vector, the equilibrium can be established without intra-union income transfer and the utility of every country in the customs union can be improved when the customs union consists of three countries.