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‡ Identify the stages of economic integration.
‡ Discuss the static and dynamic effects of a
regional trading arrangement.
‡ Assess the nature and operation of the EU.
‡ Discuss the advantages and disadvantages of
the NAFTA.
‡ Identify the reforms that the transition
economies have implemented to improve their
standard of living.

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› regional trade blocs could be a complement to
multilateralism by setting a precedent which
other nations will follow
› can lead to deeper integration
› however regional agreements are also
discriminatory in that some nations are
treated differently than others
› decreases incentives for nations to pursue
multilateral agreements
› trade bloc members may not gain additional
economies of scale through multilateralism
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› free-trade area ± agreement to remove trade
barriers among members
u u

› customs union ± agreement to remove trade
barriers among members and impose uniform
trade restrictions against non-members
u u u u
› common market ± agreement that permits (1)
free trade among members; (2) common
external trade restrictions; and (3) free
movement of factors of production
u u
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› economic union ± common market agreement
with :
1) common national, taxation, fiscal, and social
policies among members
2) transfers of sovereignty to a supranational
authority
u u u   u 
› monetary union ± economic union with
additional characteristic of common monetary
policy and common currency
u u uu

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·ith Tariff:
(before customs union)
red triangle = consumer
surplus
green triangle =
producer surplus
black rectangle = tariff
revenue
a + b = deadweight loss

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·ith Customs Union:
agreement with Germany
will lower the price to SG
trade-creation effect:
welfare losses now part
of consumer surplus
a = production effect
b = consumption effect
trade-diversion effect:
area c
lost benefits from lower
cost suppliers
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› economies of scale ± access to a larger
market allows producers to become more
efficient through greater specialization, better
equipment, and usage of by-products
› greater competition ± increased number of
producers makes collusion less likely and
forces firms to become more efficient
› stimulus of investment ± because of
increased rate of return and ability to spread
R&D costs trade makes greater levels of
investment more likely
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Treaty of Rome ± 1957 ± established European
Community ± precursor to EU
1) 1957: Belgium, France, Italy, Luxembourg,
Netherlands & ·est Germany
2) 1973: United Kingdom, Ireland & Denmark
3) 1981: Greece
4) 1987: Spain & Portugal
5) 1995: Austria, Finland & Sweden
6) 2004: Cyprus, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Malta, Poland,
Slovakia & Slovenia
7) 2007: Bulgaria & Romania | ,
 
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› EU members removed tariffs in 1968 leading


to fivefold increase in trade
› EU adopted common external tariffs in 1970
making it a customs union
› trade creation: machinery, transportation
equipment, chemicals & raw materials
› trade diversion: agricultural commodities and
raw materials
› trade creation exceeded trade diversion
› EU saw increases in economies of scale,
competition & investment
› 1985 EU eliminated nontariff barriers resulting
in creation of European common market | 
 
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› 1991 Maastricht Treaty established monetary


union and euro as common currency by 2002
› convergence criteria:
1) inflation ” 1.5% above average inflation of
three countries with lowest inflation
2) long term interest rates ” 2.0% above
average of same three countries
3) exchange rate within target bands of
monetary union for 2 years
4) budget deficit ” 3.0% of GDP
5) government debt ” 60.0% of GDP
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› no restriction on agriculture traded internally
› EU policy based in part on variable levies
› adjusted to maintain
desired price levels
› more restrictive than
an import quota in
that foreign
producers cannot cut
prices and absorb
tariff cost to maintain
export sales
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› export subsidies also used to maintain higher
prices of EU - common policy
› EU producers
sell for low price
but receive
higher price
› EU purchases
any surplus
› surplus then
sold on world
market for lower
price | 
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› government purchases previously limited primarily
to domestic producers
› 1992 EU required bidding process from EU firms
› benefits:
‡ governments
purchase from
lower cost
producers
‡ increased
competition
‡ remaining firms
produce with
economies of
scale
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A common currency also implied the need for a
single European Central Bank responsible for all
monetary and exchange rate policies of the EMU.
› advantages:
‡ eliminated exchange rate risk
‡ reduced currency conversion costs
‡ insulation from monetary disturbance &
speculation
› disadvantages:
‡ loss of individual monetary authority
‡ transition to common currency could lead to
speculative attacks
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› definition ± region in which it is economically
preferable to have a single official currency
› success of common currency area:
‡ similar business cycles
‡ similar economic structures
‡ single monetary policy affecting all members in
same manner
‡ absence of legal or cultural barriers that would limit
labor mobility
‡ wage flexibility
‡ stabilizing transfer system
› EU concerns based on rigid wages and limited
labor mobility tied to cultural factors
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› free trade area for U.S., Canada & Mexico but
not a customs union
› issues:
‡ U.S. & Canada represented developed
economies while Mexico was a developing
economy
‡ Mexico¶s authoritarian political system
‡ substantial difference in standard of living
between Mexico and Canada & U.S.
› decision: integrate Mexico to stimulate
development or allow problems in that nation
to continue to spill over borders
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› substantial benefits for Mexico because it
integrated with much larger economies
› increase in production of goods in which it has
comparative advantage
› gains at the expense of other low-wage
nations
› increases in agricultural goods and labor
intensive goods
› agriculture represents small portion of GDP
but supports roughly 25% of the population

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› Benefits:
‡ maintain status in international trade
‡ free trade preference in U.S. market
‡ equal access to Mexico¶s market
‡ inclusion in future free trade area with
Central & South America
‡ economies of scale associated with
increased output levels
› Possible Cost: closer integration with U.S. as
potential threat to Canada¶s social welfare
system
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› access to additional markets increases demand
› Canadian
producers can
sell more
autos
› increased
consumer
surplus due to
lower price
› no worse for
producers
since costs
have dropped | 
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› Benefits:
‡ expanded trade
‡ increased competition and lower prices
‡ enhanced economies of scale
‡ decrease in illegal immigration
‡ improved political stability in Mexico
› Costs:
‡ U.S. industries competing with imports
‡ impact on unskilled workers domestically
‡ potential for environmental consequences
‡ limited benefits due to relative size of these
economies
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› ·ould NAFTA cause many U.S. companies to
relocate to Mexico due to lower wages?
› Productivity is a major factor in determining cost
per unit of output.

› Based on higher productivity, U.S. workers can


still receive higher wages. | 
45!

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› measures of economic integration: Canada &
Mexico are the U.S. largest trading partners
› Canada & U.S.: advanced industrial
economies with similar per capita incomes,
inflation rates and interest rates
› Mexico: lower average per capita income,
higher inflation rate, higher interest rates, and
volatile exchange rate
› Mexico adopting U.S. dollar:
pro: price & interest rate stability
con: loss of independent monetary policy
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› 1994 proposal calling for agreement among
34 nations in North and South America
› potential to become largest trading bloc in the
world with 850 million consumers and $14
trillion in combined income
› progressive Latin American trade policies:
‡ reduced governmental management
‡ conventional macroeconomic policies to promote
growth and stability
‡ failure of import substitution model
› challenges:
› other free trade agreements
› subsidies on agricultural goods | 
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› nations making the transition from centrally
planned to market economy
› countries
opting for
greater
political &
economic
freedom
have seen
improved
performance
and income
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