International Economics
International Trade
Forms of Economic Integration
- Free Trade Area: An agreement to eliminate tariffs, quotas, and preferences on most goods and services traded between member countries.
- Customs Union: A free trade area with a common external tariff and common external trade policy.
- Common Market: A customs union with relatively free movement of capital and services.
- Full Economic Union: The final stage of economic integration, characterized by complete harmonization of economic policies.
Effects of Economic Integration
Positive Effects:
- Increased economies of scale (trade effect).
- Increased competition, leading to lower prices and production costs.
- Increased opportunities for business investments.
Negative Effects:
- Potential disappearance of less competitive firms that were protected by tariffs.
- Need for firms to adapt to a larger and more competitive market.
Trade Creation and Trade Diversion
- Trade Creation: The net volume of new trade resulting from forming or joining a trade bloc.
- Trade Diversion: The volume of trade shifted from low-cost outside exporters to higher-cost bloc-partner exporters.
The net effect of a trade bloc on a country’s well-being depends on whether trade creation or trade diversion is greater.
Short-Term and Long-Term Effects
A larger market created by economic integration brings about both short-term (static) and medium to long-term (dynamic) effects.
Effects on Developing Countries
Economic integration can have specific effects on developing countries, including:
- Lower costs of production factors.
- Improved investment climate due to integration agreements.
- Potential investment deviation.
Building Blocs vs. Stumbling Blocs
- Building Blocs: Regional agreements seen as steps towards a more open international trade system.
- Stumbling Blocs: Regional agreements seen as obstacles to a more open international trade system.
Regionalism vs. Multilateralism
- Regionalism: The principle or system of dividing a city, state, etc., into separate administrative regions.
- Multilateralism: Multiple countries working together on a given issue. This approach opposes bilateral and discriminatory arrangements that can favor powerful countries and potentially lead to international conflict.
Exchange Rate Systems
Exchange rate systems determine the price of one nation’s currency in terms of another nation’s currency. Common types include:
- Fixed: The exchange rate is fixed to a specific value.
- Hybrid: A combination of fixed and floating elements.
- Floating: The exchange rate is determined by market forces.
Spot and Forward Exchange Rates
- Spot Exchange Rate: The price for immediate exchange (up to 2 working days from the agreement).
- Forward Exchange Rate: The price set now for an exchange that will take place in the future.
Currency Appreciation and Depreciation
A currency is expected to appreciate if its interest rate is higher than the interest rate in another country. Conversely, it is expected to depreciate if its interest rate is lower.
Factors Affecting Spot Exchange Rates
The spot exchange rate (price of foreign currency in units of our currency) increases if:
- There is an increase in our money supply relative to the foreign money supply (Ms/Msf).
- There is an increase in foreign real GDP relative to our real GDP (Yf/Y).
International Monetary Cooperation
Bretton Woods System (1944-1971)
The Bretton Woods system established a fixed exchange rate system based on the US dollar. It aimed to promote international monetary cooperation and stabilize exchange rates.
Post-Bretton Woods Era
The collapse of the Bretton Woods system led to a more flexible exchange rate system. Key periods include:
- 1973-1979: Turbulence and uncertainty in the international monetary system.
- 1979-1985: Attempts to manage exchange rates through international cooperation.
- 1985-1997: Increased world financial integration and globalization.
- 1997-2008: Continued globalization and the emergence of new economic powers.
- 2008-Present: The global financial crisis and its aftermath.
European Monetary Integration
Maastricht Treaty (1992)
The Maastricht Treaty paved the way for the creation of the euro, the single currency of the European Union. It also established the European Central Bank (ECB) and set out the criteria for countries to join the eurozone.
European Monetary System (EMS)
The EMS, established in 1979, aimed to stabilize exchange rates among European currencies. It served as a precursor to the euro.
Causes of Asymmetric Shocks
Asymmetric shocks, which affect different countries or regions differently, can pose challenges to monetary integration. Main causes include:
- Cycle Asynchronicity: Different countries may be at different stages of the economic cycle.
- Monetary and Financial Differences: Differences in monetary policies, financial systems, and levels of financial development.
- Productive Asymmetries: Differences in industrial structures, productivity levels, and competitiveness.
Optimal Number of Firms in an Integrated Market
The optimal number of firms in an integrated market can be estimated using the following formula:
N = Market Size / Minimum Efficient Scale (MES)
where:
- N: Optimal number of firms
- Market Size: Total demand in the integrated market
- MES: The minimum level of output at which a firm can produce at a competitive cost