Trade Agreements vs. Unilateral Tariff Reductions: Evidence from Modeling with a Continuum of Goods.

The relative merits of preferential trading agreements and unilateral tariff reduction are investigated, yielding the conclusion that preferential agreements are superior for plausible specifications of tastes and endowments. The attractiveness of agreements, however, depends crucially on general-equilibrium effects on intraunion and external terms of trade. Game-theoretic differences between the alternative policy strategies are emphasized: agreements are cooperative equilibria while unilateral action defines a noncooperative Stackelberg equilibrium. The analytical framework is a three-country variant of the Dornbusch-Fischer-Samuelson classical trade model. Numerical simulations also illustrate that agreements may enhance government revenue and "learning-by-doing." Copyright 1989 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.