This thesis analyzes the effect of uncertainty on illegal transactions. The major results of the existing literature are reexamined with regards to trade tax revenues and the social welfare effects of smuggling. New insight is gained on the theoretical implications of smuggling by analyzing how the behavior of smuggling firms is affected by the uncertainty associated with illegal trade. Firm behavior with a risk attached to illegal trade has an impact on how government enforcement affects trade tax revenues and social welfare. This thesis is in three essays. In the first essay agents have a choice of either being involved in legal trade or illegal trade. Illegal trade has a risk attached to it, with the magnitude of risk being dependent on the level of government enforcement. The risk factor allows, as a general result, the coexistence of legal and illegal trade with price disparity. The essay's main focus is on the welfare effect of smuggling, and it concludes that contrary to earlier research on illegal trade, the presence of illegal trade, even with a real resource cost associated with it, is beneficial to social welfare. This result is dependent on the attitude of exporting firms towards the risk associated with smuggling. In the second essay, the government is modeled as a profit maximizing agent. We demonstrate that over-enforcement of the trade tax laws is detrimental to revenue collection and not a socially optimal policy solution to smuggling. The third essay is a theoretical discussion of how to empirically test and compare the economic impact of smuggling on Indonesian domestic wholesale prices before and after the Indonesian trade liberalization efforts of 1985-86. The theoretical results from the first two essays suggest that trade liberalization should reduce the economic impact of smuggling by reducing the incentive to smuggle.