Economic Integration

Question 1

What are the different forms of economic integration?

Answer 1

• Preferential trade arrangement (PTA).
• Free trade area (FTA)
• Customs union
• Common market
• Economic union
NOTE:real world example needed for each

Question 2

What is the definition of a preferential trade arrangement?

Answer 2

Member countries agree to set lower barriers (e.g. lower tariff) to trade within the group than with non-member countries

Question 3

What is a free trade area (FTA)?

Answer 3

Involves eliminating barriers (e.g. no tariffs) to intra-group trade while allowing each country to maintain its own barriers to trade with non-members.

Question 4

What is the potential problem with a free trade area?

Answer 4

• Within an FTA some countries will have higher outside tariffs than others.
• A firm from a country outside the FTA may export to the lower tariff country and use it as an intermediary country to get to the other countries in the FTA

Question 5

What is the solution to the problem in a FTA?

Answer 5

• Rules of origin
• This determines the national source of a product when countries withing a FTA export to each other
• This means that if C exports to A and then B, they will have pay B tariff restrictions

Question 6

What is a customs union?

Answer 6

Intra-group trade faces no barriers and members

maintain a common external tariff on trade with non-members (solves FTA issues)

Question 7

What is a common market?

Answer 7

Extends free trade among members to factors of
production (labour migration and capital flows), as well
as to goods and services.

Question 8

What is an economic union?

Answer 8

In addition to common market, members
harmonize or even unify the monetary and fiscal
policies e.g. EU with the Euro and ECB

Question 9

What is trade creation?

Answer 9

Occurs when some domestic production in a member nation is replaced by lower-cost imports from another member.

Question 10

What does trade creation lead to?

Answer 10

• Leads to increased welfare for members as nations
specialize in comparative advantages.
i.e. trade gains from the Ricardian model.

Question 11

Explain the graph of trade creation

Answer 11

• Pre-tariff=b is cheaper so A imports from B
• Customs union formed between a&b and A still imports from B but imports are larger, domestic production therefore decreases and price
• Domestic production replaced by lower cost imports

Question 12

What are the welfare effects of trade creation?

Answer 12

Consumer: +(a+b+c+d)
Producer (domestic): - a-loss in rpice
Government: - c (lost tariff revenue)
Total welfare: + (b+d)
Trade creation increases welfare.
analysis is similar to the reverse of tariff in a small country.

Question 13

What is trade diversion?

Answer 13

Occurs when lower-cost imports from non-members are replaced by higher-cost imports from members

• due to the removal of tariff for members
• In isolation, diversion reduces welfare as it shifts resources away from CA-opposite of specialisation

Question 14

Explain the trade diversion graph pre customs union

Answer 14

• Country A and B are forming a customs union.
• Before forming the customs union, country A sets
identical tariffs for B and C.
• The pre-tariff price of country B is higher than the pre-tariff price of the same product
from country C.
• As a result, country A imports from country C

Question 15

Explain the trade diversion after the customs union is formed

Answer 15

• When union is formed, tariffs imports from B are gone so B is cheaper than C to import (PC+T > PB)
• Trade is diverted from country C to country B, from lower-cost mports to higher-cost pre-tariff imports

Question 16

What are the trade creation effects of trade diversion?

Answer 16

• Trade diversion customs union also has trade creation effect: more imports, and less production because of lower-cost imports
• Trade diversion decreases welfare while trade creation increases welfare.

Question 17

What are the overall welfare effects of trade diversion?

Answer 17

• Consumers gain
• Producers lose
• Gov lose
Total welfare can be a loss or gain depending on how big the consumer gain is vs gov loss

Question 18

When is trade creation (postive welfare) more likely to greater than trade diversion (negative welfare)?

Answer 18

• Initial tariff is high-so diversion leads to large price decrease and big consumer surplus gain
• Initial price difference between B and C is small meaning less tariff is lost so trade creation effects are larger

Question 19

What are the dynamic benefits of a customs union?

Answer 19

• Increased competition.
• Economies of scale.
• Stimulus to investment.
• Better utilization of economic resources.
NOTE: more benefits exist

Question 20

Explain the dynamic benefit of a customs union of increased competition?

Answer 20

• In a customs union with no trade barriers, procuers have to be more efficient to meet the competition in te union
• This can stimulate development and utilisation of R&D

Question 21

Explain the dynamic benefit of a customs union of economies of scale

Answer 21

With no trade barriers, significant economies of scale can be achieved as there is a larger economy to serve

Question 22

Explain the dynamic benefit of a customs union of stimulus to investment

Answer 22

• More competition may lead to increased investment i.e. expansion in order to gain a competitive advantage
• FDI increases from outside into the union so outside firms can avoid tariffs/exploit the union market

Question 23

Explain the dynamic benefit of a customs union of better utilisation of economic resources

Answer 23

• Free movement of production factors increases
the efficiency of utilization of economic resources
• Capital and labour will move to where they are
more efficiently utilized and consequently better
paid

Question 24

What is a disadvantage of a customs union?

Answer 24

Cannot negotiate own trade deal with outside members