Delegation in Customs Union Formation

Abstract

This paper deals with the issue of delegation between potential member countries while forming a Customs Union (CU) under a vertically differentiated monopoly in a three country world. Under universal market coverage, CU formation can be sustained with both the member countries preferring CU over setting tariff unilaterally and non-cooperatively but differing in the choice of the member being delegated the tariff-setting power. However, if the country with smaller relative taste diversity is smaller in size, then CU formation can’t be sustained as a unique NE since both will prefer to set tariffs unilaterally and non-cooperatively over delegating the tariff-setting power and form a CU.