ECONOMICS Johnson Hsu July 2014. The global economy 1.Macroeconomic performance 2.Trade and integration 3.Development and sustainability 4.The economics.

ECONOMICSECONOMICS

Johnson HsuJohnson Hsu

July 2014July 2014

The global economyThe global economy

1.1. Macroeconomic performanceMacroeconomic performance

2.2. Trade and integrationTrade and integration

3.3. Development and Development and sustainabilitysustainability

4.4. The economics of The economics of globalisationglobalisation

World Trade World Trade OrganizationOrganization

An international body An international body responsible for negotiating responsible for negotiating trade agreements and trade agreements and ‘policing’ the rules of trade ‘policing’ the rules of trade to which its members sign to which its members sign up. Trade disputesup. Trade disputes

between members arebetween members are settled by the WTOsettled by the WTO

Absolute advantageAbsolute advantage Where one country is able to produce more oWhere one country is able to produce more o

f a good or service with the same amount of rf a good or service with the same amount of resources, such that the unit cost of productioesources, such that the unit cost of production is lowern is lower

refers to the ability of a party (an refers to the ability of a party (an individual, or firm, or country) to produce individual, or firm, or country) to produce more of a good or service than more of a good or service than competitors, using the same amount of competitors, using the same amount of resources resources

Example 1 Example 1

Party B has the absolute advantage.Party B has the absolute advantage.Party A can produce 5 widgets per hour with 3 Party A can produce 5 widgets per hour with 3 employees.employees.Party B can produce 10 widgets per hour with 3 Party B can produce 10 widgets per hour with 3 employees.employees.Assuming that the employees of both parties are paid Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party Party B can produce twice as many widgets as Party A can with the same number of employees.A can with the same number of employees.

Example 2 Example 2 One of your friends, Gina, can print 5 t-One of your friends, Gina, can print 5 t-

shirts or build 3 birdhouses an hour. shirts or build 3 birdhouses an hour. Your other friend, Mike, can print 3 t-Your other friend, Mike, can print 3 t-shirts an hour or build 2 birdhouses an shirts an hour or build 2 birdhouses an hour. Because your friend Gina is more hour. Because your friend Gina is more productive at printing t-shirts and productive at printing t-shirts and building birdhouses compared to Mike, building birdhouses compared to Mike, she has an absolute advantage in both she has an absolute advantage in both printing t-shirts and building birdhouses.printing t-shirts and building birdhouses.

Example 3Example 3 Suppose Gina wasn't as agile with the Suppose Gina wasn't as agile with the

hammer and could only make 1 birdhouse an hammer and could only make 1 birdhouse an hour, but she took a hour, but she took a sewing class and could class and could print 10 t-shirts an hour. Mike on the other print 10 t-shirts an hour. Mike on the other hand takes woodworking and so he can build hand takes woodworking and so he can build 5 birdhouses an hour, but he doesn't know 5 birdhouses an hour, but he doesn't know the first thing about making t-shirts so he the first thing about making t-shirts so he can only print 2 t-shirts an hour. While Gina can only print 2 t-shirts an hour. While Gina would have the absolute advantage in would have the absolute advantage in printing shirts, Mike would have an absolute printing shirts, Mike would have an absolute advantage in building birdhouses.advantage in building birdhouses.

Reciprocal absolute Reciprocal absolute advantageadvantage

where, is a theoretical where, is a theoretical world of two countries and world of two countries and two products, each country two products, each country has an absolute advantage has an absolute advantage in one of the two productsin one of the two products

Comparative Comparative advantageadvantage

Where one country produces a Where one country produces a good or service at a lower relative good or service at a lower relative opportunity cost than othersopportunity cost than others

Absolute vs ComparativAbsolute vs Comparative Advantagee Advantage

Comparative advantage can be described as the ability Comparative advantage can be described as the ability of a particular country to produce a certain product of a particular country to produce a certain product better than another country. A country will have an better than another country. A country will have an absolute advantage over another country when it absolute advantage over another country when it produces the highest number of goods after the same produces the highest number of goods after the same resources are supplied to both of them.resources are supplied to both of them.

While absolute advantage is a condition where the While absolute advantage is a condition where the trade is not mutually beneficial, comparative trade is not mutually beneficial, comparative advantage is a condition in which the trade is mutually advantage is a condition in which the trade is mutually beneficial.beneficial.

While cost is a factor involved in absolute advantage, While cost is a factor involved in absolute advantage, opportunity cost is the factor that is involved in opportunity cost is the factor that is involved in comparative advantage.comparative advantage.

Unlike absolute advantage, comparative advantage is Unlike absolute advantage, comparative advantage is always reciprocal and mutual.always reciprocal and mutual.

Relative opportunity Relative opportunity costcost

The cost of production of one The cost of production of one good or service in term of the good or service in term of the sacrificed output of another sacrificed output of another good or service in one country good or service in one country relative to anotherrelative to another

What Is Law of What Is Law of Increasing Increasing

Opportunity Cost?Opportunity Cost?Ans: Ans: The Law of Increasing Relative Cost, also know as, the The Law of Increasing Relative Cost, also know as, the Law of Diminishing Returns is a term used in economiLaw of Diminishing Returns is a term used in economics which suggests that diminishing returns as a decreacs which suggests that diminishing returns as a decrease in marginal output of a production process is the sinse in marginal output of a production process is the single a factor of production while all other factors are cogle a factor of production while all other factors are constant. Though the marginal productivity of the workfnstant. Though the marginal productivity of the workforce decrease, the output increases, and the number oorce decrease, the output increases, and the number of workers exceed the number of available workspace. f workers exceed the number of available workspace.

Term of tradeTerm of tradeThe price of a country’s exports The price of a country’s exports

relative to the price of its imports. relative to the price of its imports. The terms of trade can measured The terms of trade can measured using the formula:using the formula:

Index of average export pricesIndex of average export prices

------------------------------------- x 100------------------------------------- x 100

Index of average import pricesIndex of average import prices

Trading possibility Trading possibility curvecurve

A representation of all the A representation of all the combinations of two products combinations of two products that a country can consume if it that a country can consume if it engages in international trade. engages in international trade. The TPC lies outside the The TPC lies outside the production possibility curve, production possibility curve, showing the gains in showing the gains in consumption possible from consumption possible from international tradeinternational trade

Factor endowmentsFactor endowmentsThe mix of land, labour and capiThe mix of land, labour and capi

tal that a country possesses. Factal that a country possesses. Factor endowments can be determitor endowments can be determined by, among other things, geoned by, among other things, geography, historical legacy, and ecgraphy, historical legacy, and economic and social developmentonomic and social development

Factor intensitiesFactor intensities The balance between land, labour and capital required in tThe balance between land, labour and capital required in t

he production of a good or servicehe production of a good or service Measuring factor intensity in the real world is not a Measuring factor intensity in the real world is not a

simple task. Numerous factors of production exist; a simple task. Numerous factors of production exist; a country's abundant factor may depend on the countries country's abundant factor may depend on the countries being compared, and an intensive factor may depend on being compared, and an intensive factor may depend on the industries being compared. For example, consider the industries being compared. For example, consider the labor-to-land ratio among different countries by the labor-to-land ratio among different countries by assuming that a country's labor force is a constant assuming that a country's labor force is a constant fraction of its population. Compare the population-to-fraction of its population. Compare the population-to-land ratio (population density) in the United States to land ratio (population density) in the United States to that in the United Kingdom. Then compare the ratio in that in the United Kingdom. Then compare the ratio in the United States to that in Australia. Do you expect the the United States to that in Australia. Do you expect the United States to be a net exporter of agricultural goods United States to be a net exporter of agricultural goods because of its "abundance" or "scarcity" of labor? because of its "abundance" or "scarcity" of labor? Depending on how you compare the US to other Depending on how you compare the US to other countries, it is hard to predict.countries, it is hard to predict.

Labour-intensive produLabour-intensive productionction

Any production process that involveAny production process that involves a large amount of labour relative ts a large amount of labour relative to other factors of productiono other factors of production

Capital-intensive Capital-intensive productionproduction

Where the production of a Where the production of a good or service requires a good or service requires a large amount of capital large amount of capital relative to other factors of relative to other factors of productionproduction

Heckscher-Ohlin theory of Heckscher-Ohlin theory of international tradeinternational trade

A theory that a country will export producA theory that a country will export products produced using factors of production thts produced using factors of production that are abundant and import products whoat are abundant and import products whose production requires the use of scarce fse production requires the use of scarce factorsactors

The model essentially says that The model essentially says that countries will export products that use countries will export products that use their abundant and cheap factor(s) of their abundant and cheap factor(s) of production and import products that production and import products that use the countries' scarce factor(s) use the countries' scarce factor(s)

Theoretical Theoretical assumptions of assumptions of HeckschHecksch

er-Ohliner-Ohlin Both countries have identical production Both countries have identical production

technology technology Production output is assumed to exhibit Production output is assumed to exhibit

constant returns to scale constant returns to scale The technologies used to produce the two The technologies used to produce the two

commodities differ commodities differ Factor mobility within countries Factor mobility within countries Factor immobility between countries Factor immobility between countries Commodity prices are the same everywhere Commodity prices are the same everywhere Perfect internal competition Perfect internal competition

Infant industriesInfant industriesIndustries in an economy that Industries in an economy that

are relatively new and lack the are relatively new and lack the economies of scale that would economies of scale that would allow them to compete in allow them to compete in international markets against international markets against more established competitors more established competitors in other countriesin other countries

Profit marginProfit marginThe difference between a firm’s The difference between a firm’s

revenue and cost expressed as a revenue and cost expressed as a percentage of revenuepercentage of revenue

Dynamic Dynamic efficienciesefficiencies

Efficiencies that occur over time.Efficiencies that occur over time. International trade can lead to c International trade can lead to change in behavior over a period hange in behavior over a period of time that can increase producof time that can increase productive and allocative efficiencytive and allocative efficiency

Knowledge and Knowledge and technology transfertechnology transfer

The process by which The process by which knowledge and technology knowledge and technology developed in one country is developed in one country is transferred to another, transferred to another, often through licensing and often through licensing and franchising franchising

Licensing Licensing arrangementarrangement

An agreement that ideas and An agreement that ideas and technology ‘owner’ by one technology ‘owner’ by one company can be used by company can be used by another, often for a chargeanother, often for a charge

Regional trading Regional trading blocbloc

Countries in a region that have formed an ‘eCountries in a region that have formed an ‘economic club’ based on abolishing tariffs anconomic club’ based on abolishing tariffs and non-tariff barriers to trade, e.g. the Europead non-tariff barriers to trade, e.g. the European Union, the North American Free Area and tn Union, the North American Free Area and the Association of South East Asian Nationshe Association of South East Asian Nations

is a type of intergovernmental agreement, is a type of intergovernmental agreement, often part of a regional intergovernmental often part of a regional intergovernmental organization, where regional barriers to organization, where regional barriers to trade, (tariffs and non-tariff barriers) are trade, (tariffs and non-tariff barriers) are reduced or eliminated among the reduced or eliminated among the participating states. participating states.

Advantages and Advantages and Disadvantages of trade Disadvantages of trade

blocsblocs There are five major advantages of There are five major advantages of

trade bloc agreements: foreign direct trade bloc agreements: foreign direct investment, economies of scale, investment, economies of scale, competition, trade effects, and competition, trade effects, and market efficiency.market efficiency.

The disadvantages, on the other The disadvantages, on the other hand, include: regionalism vs. hand, include: regionalism vs. multinationalism, loss of sovereignty, multinationalism, loss of sovereignty, concessions, and interdependence. concessions, and interdependence.

Primary Primary commoditiescommodities

Goods produced in the Goods produced in the primary sector of the primary sector of the economy, such as coffee economy, such as coffee and tinand tin

Prebisch-Singer hypoPrebisch-Singer hypothesisthesis

The argument that countries exporting prThe argument that countries exporting primary commodities will face declining terimary commodities will face declining terms of trade in the long run, which will trams of trade in the long run, which will trap them in a low of development as more ap them in a low of development as more and more exports will need to be sold to ‘nd more exports will need to be sold to ‘pay for’ the same volume of imports of spay for’ the same volume of imports of secondary sector or capital goodsecondary sector or capital goods

postulates that terms of trade, between postulates that terms of trade, between primary products and manufactured primary products and manufactured goods, deteriorate in time. goods, deteriorate in time.

Developed economiesDeveloped economies Countries with a high income Countries with a high income

per capita and diversified per capita and diversified industrial and tertiary sectors industrial and tertiary sectors of the economy. Examples of of the economy. Examples of developed economies would developed economies would include the USA, the UK, include the USA, the UK, Japan and South KoreaJapan and South Korea

Developing Developing economieseconomies

Countries with relative low Countries with relative low income per capita, an economy income per capita, an economy in which the industrial sector is in which the industrial sector is small or undeveloped and small or undeveloped and where primary sector where primary sector production is a relatively large production is a relatively large part of total GDP part of total GDP

LiberalisationLiberalisation Reduction in the barriers to Reduction in the barriers to

international trade, in order international trade, in order to allow foreign firms to gain to allow foreign firms to gain access to the market for access to the market for goods and services that are goods and services that are traded internationallytraded internationally

Transition economiesTransition economies Economies in the process Economies in the process

of changing from central of changing from central planning to the free planning to the free marketmarket

Intra-regional Intra-regional tradetrade

Trade between countries Trade between countries in the same geographical in the same geographical area, for example trade area, for example trade between the UK and between the UK and Germany or the USA and Germany or the USA and CanadaCanada

Inter-industry Inter-industry tradetrade

Trade involving the Trade involving the exchange of goods and exchange of goods and services produced by services produced by different industriesdifferent industries

Intra-industry Intra-industry tradetrade

Trade involving the Trade involving the exchange of goods and exchange of goods and services produced by the services produced by the same industrysame industry

Freely floating Freely floating exchange rateexchange rate

A system whereby the A system whereby the price of one currency price of one currency expressed in terms of expressed in terms of another is determined by another is determined by the forces of demand and the forces of demand and supplysupply

Fixed exchange Fixed exchange raterate

An exchange rate system in An exchange rate system in which the value of one which the value of one currency has a fixed value currency has a fixed value against other countries. This against other countries. This fixed rate is often set by the fixed rate is often set by the governmentgovernment

Semi-fixed/semi-Semi-fixed/semi-floating exchange floating exchange

raterateAn exchange rate system An exchange rate system

that allows a currency’s that allows a currency’s value to fluctuate within a value to fluctuate within a permitted bank of permitted bank of fluctuationfluctuation

Foreign exchange Foreign exchange marketmarket

A term used to describe A term used to describe the coming together of the coming together of buyers and sellers of buyers and sellers of currenciescurrencies

Short-term capital Short-term capital flowsflows

Flows of money in and out Flows of money in and out of a country in the form of of a country in the form of bank deposits. Short-term bank deposits. Short-term capital flows are highly capital flows are highly volatile and exist to take volatile and exist to take advantage of changes in advantage of changes in relative interest ratesrelative interest rates

Long-term capital Long-term capital transactionstransactions

Flows of money related to Flows of money related to buying and selling of buying and selling of assets, such a land or assets, such a land or property or production property or production facilities or shares in facilities or shares in companies.companies.

External economic External economic shocksshocks

Unexpected events coming Unexpected events coming from outside the economy that from outside the economy that cause unpredicted changes in cause unpredicted changes in AS or AD. Examples might AS or AD. Examples might include rapid rises in oil prices include rapid rises in oil prices or a global slowdownor a global slowdown

Purchasing power Purchasing power parityparity

The exchange rate that equaliseThe exchange rate that equalises the price of a basket of identics the price of a basket of identical traded goods and services in tal traded goods and services in two different countries. PPP is an wo different countries. PPP is an attempt to measure the true valuattempt to measure the true value of a currency in terms of the ge of a currency in terms of the goods and services it will buyoods and services it will buy

J-curve effectJ-curve effect Shows the trend in a country’s balance of Shows the trend in a country’s balance of

trade following a depreciation of the trade following a depreciation of the exchange rate. A fall in the exchange rate exchange rate. A fall in the exchange rate causes an initial worsening of the balance of causes an initial worsening of the balance of trade, as higher import price raise the value trade, as higher import price raise the value of imports and lower export prices reduce of imports and lower export prices reduce the value of exports due to short-run the value of exports due to short-run inelasticity of the demand for imports and inelasticity of the demand for imports and exports. Eventually the trade balance exports. Eventually the trade balance improves. An appreciation of the currency improves. An appreciation of the currency causes an inverted J-curve effectcauses an inverted J-curve effect

Slide 16-55Copyright © 2003 Pearson Education, Inc.

2

Figure: The J-Curve

Time

Current account (in domestic output units)

1 3

Long-runeffect of real depreciationon the currentaccount

Real depreciation takes place and J-curve begins

End of J-curve

The J-CurveThe J-Curve

Marshall-Lerner Marshall-Lerner conditioncondition

StatesStates that for a depreciation of that for a depreciation of the currency to improve the balthe currency to improve the balance of trade the sum of the priance of trade the sum of the price elasticities of demand for imce elasticities of demand for imports and exports must be great ports and exports must be great than 1than 1

HedgingHedging Business strategy that limits the risk that lBusiness strategy that limits the risk that l

osses are made from changes in the price osses are made from changes in the price of currencies or commoditiesof currencies or commodities

is an investment position intended to is an investment position intended to offset potential losses/gains that may offset potential losses/gains that may be incurred by a companion be incurred by a companion investment. In simple language, a investment. In simple language, a hedge is used to reduce any substantial hedge is used to reduce any substantial losses/gains suffered by an individual losses/gains suffered by an individual or an organization.or an organization.

Hedging strategies Hedging strategies Forward exchange contract for currenciesForward exchange contract for currencies Currency future contractsCurrency future contracts Money Market Operations for currenciesMoney Market Operations for currencies Forward Exchange Contract for interestForward Exchange Contract for interest Money Market Operations for interestMoney Market Operations for interest Future contracts for interestFuture contracts for interest Covered Calls on equitiesCovered Calls on equities Short Straddles on equities or indexesShort Straddles on equities or indexes

Categories of hedgeable risk

Commodity risk: the risk that arises from potential movements in the : the risk that arises from potential movements in the value of commodity contracts, which include agricultural products, value of commodity contracts, which include agricultural products, metals, and energy products.[3]metals, and energy products.[3]

Credit risk: the risk that money owing will not be paid by an obligor. Credit risk: the risk that money owing will not be paid by an obligor. Since credit risk is the natural business of banks, but an unwanted risk Since credit risk is the natural business of banks, but an unwanted risk for commercial traders, an early market developed between banks and for commercial traders, an early market developed between banks and traders that involved selling obligations at a discounted rate.traders that involved selling obligations at a discounted rate.

Currency risk (also known as Foreign Exchange Risk hedging) is used Currency risk (also known as Foreign Exchange Risk hedging) is used both by financial investors to deflect the risks they encounter when both by financial investors to deflect the risks they encounter when investing abroad and by non-financial actors in the global economy for investing abroad and by non-financial actors in the global economy for whom multi-currency activities are a necessary evil rather than a whom multi-currency activities are a necessary evil rather than a desired state of exposure.desired state of exposure.

Interest rate risk: the risk that the relative value of an interest-bearing Interest rate risk: the risk that the relative value of an interest-bearing liability, such as a loan or a bond, will worsen due to an interest rate liability, such as a loan or a bond, will worsen due to an interest rate increase. Interest rate risks can be hedged using fixed-income increase. Interest rate risks can be hedged using fixed-income instruments or interest rate swaps.instruments or interest rate swaps.

Equity risk: the risk that one's investments will depreciate because of Equity risk: the risk that one's investments will depreciate because of stock market dynamics causing one to lose money.stock market dynamics causing one to lose money.

Volatility risk: is the threat that an exchange rate movement poses to an Volatility risk: is the threat that an exchange rate movement poses to an investor's portfolio in a foreign currency.investor's portfolio in a foreign currency.

Volumetric risk: the risk that a customer demands more or less of a Volumetric risk: the risk that a customer demands more or less of a product than expected.product than expected.

Futures marketFutures market Markets where people and businesses can Markets where people and businesses can

buy and sell contracts to buy commodities buy and sell contracts to buy commodities or currencies at a fixed price at a fixed date or currencies at a fixed price at a fixed date in the futurein the future

is a central financial exchange where is a central financial exchange where people can trade standardized people can trade standardized futures contracts; that is, a contract to ; that is, a contract to buy specific quantities of a buy specific quantities of a commodity or or financial instrument at a specified price at a specified price with with delivery set at a specified time in set at a specified time in the future.the future.

Foreign currency Foreign currency reservesreserves

Foreign currencies held by Foreign currencies held by central banks in order to central banks in order to enable intervention in the enable intervention in the FOREX markets to affect the FOREX markets to affect the country’s exchange ratecountry’s exchange rate

Bilateral exchange Bilateral exchange raterate

The exchange of one The exchange of one currency against anothercurrency against another

Effective exchange Effective exchange raterate

The exchange rate of one The exchange rate of one currency against a basket of currency against a basket of currencies of other countries, currencies of other countries, often weighted according to often weighted according to the amount of trade done with the amount of trade done with each countryeach country

Single currencySingle currencyA currency that is shared A currency that is shared

by more one country. The by more one country. The euro is shared by 15 euro is shared by 15 countries in the European countries in the European UnionUnion

Expenditure-Expenditure-switching policiesswitching policies

Policies that increase the price Policies that increase the price of imports and/or reduce the of imports and/or reduce the price of exports in order to price of exports in order to reduce the demand for import reduce the demand for import and raise the demand for and raise the demand for exports to correct a current exports to correct a current account deficit on the balance account deficit on the balance of paymentsof payments

Expenditure-switching Expenditure-switching policies can be achieved policies can be achieved

bybyA fall in the exchange rateA fall in the exchange rateTariff on importTariff on importSubsidising exportSubsidising export

Expenditure-Expenditure-reducing policiesreducing policies

Policies that reduce the Policies that reduce the overall level of national overall level of national income in order to reduce the income in order to reduce the demand for imports and demand for imports and correct a current account correct a current account deficit of the balance of deficit of the balance of paymentspayments

Expenditure-reducing Expenditure-reducing policies can be achieved policies can be achieved

byby

Raising the level of taxationRaising the level of taxation Reducing government Reducing government

expenditureexpenditure Raising interest ratesRaising interest rates

Economic integrationEconomic integration Refers to the process of blurring the boundaries Refers to the process of blurring the boundaries

that separate economic activity in one nation statthat separate economic activity in one nation state from that in anothere from that in another

is the unification of economic policies between is the unification of economic policies between different states through the partial or full different states through the partial or full abolition of tariff and non-tariff restrictions on abolition of tariff and non-tariff restrictions on trade taking place among them prior to their trade taking place among them prior to their integration. This is meant in turn to lead to integration. This is meant in turn to lead to lower prices for distributors and consumers lower prices for distributors and consumers with the goal of increasing the combined with the goal of increasing the combined economic productivity of the states. economic productivity of the states.

The degree of economic The degree of economic integration can be categorized integration can be categorized

into seven stagesinto seven stages Preferential trading areaPreferential trading area

Free trade areaFree trade area

Customs unionCustoms union

Common marketCommon market

Economic unionEconomic union

Economic and monetary unionEconomic and monetary union

Complete economic integrationComplete economic integration

Stages of Economic integrationStages of Economic integration

Trade pact typeTrade pact type

activities inside the activities inside the trade bloctrade bloc common common barriersbarriers in in externalexternal relationsrelations

eliminating barriers for exchange ofeliminating barriers for exchange of Shared Shared policiespolicies dsgoodsgoo

services

capital

labourgoods (

tariffs)

goods (non-tariff

)services

capital

labour

monetary

fiscal

Tariff

Non-tariff

Preferential trade agreement

TIFA BIT, TIFA

Free trade agreement

Economic partnershipCommon marketMonetary union

Fiscal union

Customs union

Customs and monetary unionEconomic union

Economic and monetary union

Complete economic integration

Non-tariff barriersNon-tariff barriers Things that restrict trade Things that restrict trade

other than tariffother than tariff

Trade deflectionTrade deflection Where one country in a free trade area imposes high Where one country in a free trade area imposes high

tariffs on another to reduce imports but the imports tariffs on another to reduce imports but the imports come in from elsewhere in the free trade areacome in from elsewhere in the free trade area

Trade deflectionTrade deflection

Free trade areaFree trade area An agreement between two or more couAn agreement between two or more cou

ntries to abolish tariffs on trade betweentries to abolish tariffs on trade between themn them

is a theoretical concept where a is a theoretical concept where a trade trade blocbloc whose member countries have whose member countries have signed a signed a free-trade agreementfree-trade agreement （（ FTFTAA ）） , which eliminates , which eliminates tariffstariffs, , import import quotasquotas, and preferences on most, and preferences on most （（ if if not allnot all ）） goods goods and services traded and services traded between them. between them.

Customs unionCustoms unionAn agreement between two or An agreement between two or

more countries to abolish more countries to abolish tariffs on trade between them tariffs on trade between them and to place a common and to place a common external tariff on trade with external tariff on trade with non-members. non-members.

Single marketSingle marketDeepens economic integration fDeepens economic integration f

rom a customs union by eliminarom a customs union by eliminating non-tariff barriers to trade, ting non-tariff barriers to trade, promoting the free movement of promoting the free movement of labour and capital and agreeing labour and capital and agreeing common policies in a number of common policies in a number of areasareas

Economic unionEconomic unionDeepens integration in a sinDeepens integration in a sin

gle market, centralising ecogle market, centralising economic policy at the macroecnomic policy at the macroeconomic levelonomic level

Monetary unionMonetary unionThe deepest form of The deepest form of

integration in which integration in which countries share the same countries share the same currency and have a currency and have a common monetary policy as common monetary policy as a resulta result

Monetary policy Monetary policy sovereigntysovereignty

The ability of country to The ability of country to pursue an independent pursue an independent monetary policymonetary policy

Trade creationTrade creationWhere economic integration Where economic integration

results in high-cost domestic results in high-cost domestic production being replaced by production being replaced by imports from a more efficient imports from a more efficient source within the source within the economically integrated areaeconomically integrated area

Trade diversionTrade diversion Where economic integration Where economic integration

results in trade switching results in trade switching from a low-cost supplier from a low-cost supplier outside the economically outside the economically integrated area at a less integrated area at a less efficient source with the areaefficient source with the area

The dynamic effects The dynamic effects of economic of economic integrationintegration

A reduction in monopoly A reduction in monopoly powerpower

Greater innovation and R&DGreater innovation and R&D A larger market and A larger market and

economies of scaleeconomies of scale

Transaction costsTransaction costsThe costs of trading, The costs of trading,

which includes cost of which includes cost of changing currencieschanging currencies

Stability and Growth Stability and Growth PactPact

Limits agreed to public Limits agreed to public sector borrowing and sector borrowing and national debt for those EU national debt for those EU countries that are part of countries that are part of the euro areathe euro area

Automatic stabilisersAutomatic stabilisersElements of fiscal policy that Elements of fiscal policy that

cushion the impact of the business cushion the impact of the business cycle without any need for cycle without any need for corrective action by the corrective action by the government. For example, higher government. For example, higher spending on unemployment spending on unemployment benefits and welfare payments and benefits and welfare payments and lower taxation receipts provide and lower taxation receipts provide and automatic fiscal stimulus in times of automatic fiscal stimulus in times of economic slowdowneconomic slowdown

Fiscal transferFiscal transferOccur where taxation Occur where taxation

raised in one country is raised in one country is used to fund government used to fund government expenditures in another expenditures in another countrycountry

Economic Economic convergenceconvergence

The process by which economic conditions in The process by which economic conditions in different countries become similar. Economidifferent countries become similar. Economists distinguish between monetary convergencsts distinguish between monetary convergence and real convergence. Membership of the ee and real convergence. Membership of the euro area only requires monetary convergence uro area only requires monetary convergence to have taken placeto have taken place

is the hypothesis that poorer is the hypothesis that poorer economies’per capita incomeseconomies’per capita incomes will tend to will tend to grow at faster rates than richer economies. grow at faster rates than richer economies. As a result, all economies should eventually As a result, all economies should eventually converge in terms of per capita income. converge in terms of per capita income.

Types of Types of ConvergenceConvergence

Absolute Convergence: Lower initial GDP will lead to a higher Absolute Convergence: Lower initial GDP will lead to a higher average growth rate. The implication of this is that poverty will average growth rate. The implication of this is that poverty will ultimately disappear 'by itself'. It does not explain why some nations ultimately disappear 'by itself'. It does not explain why some nations have had zero growth for many decades (e.g. in Sub-Saharan Africa)have had zero growth for many decades (e.g. in Sub-Saharan Africa)

Conditional Convergence: A country's income per worker converges Conditional Convergence: A country's income per worker converges to a country-specific long-run level as determined by the structural to a country-specific long-run level as determined by the structural characteristics of that country. The implication is that structural characteristics of that country. The implication is that structural characteristics and not initial national income determine the long-run characteristics and not initial national income determine the long-run level of GDP per worker. Thus, foreign aid should focus on structure level of GDP per worker. Thus, foreign aid should focus on structure (infrastructure, education, financial system etc.) and there is no need (infrastructure, education, financial system etc.) and there is no need for an income transfer from richer to poorer nations.for an income transfer from richer to poorer nations.

Club Convergence: It is possible to observe different "clubs" or Club Convergence: It is possible to observe different "clubs" or groups of countries with similar growth trajectories. Most groups of countries with similar growth trajectories. Most importantly, several countries with low national income also have low importantly, several countries with low national income also have low growth rates. Thus, this adds to the theory of conditional growth rates. Thus, this adds to the theory of conditional convergence that foreign aid should also include income transfers convergence that foreign aid should also include income transfers and that initial income does in fact matter for economic growth. and that initial income does in fact matter for economic growth.

Optimal currency Optimal currency areaarea

Refers to conditions that need to Refers to conditions that need to be avoid the costs of monetary ube avoid the costs of monetary union. These conditions include: nion. These conditions include: a high degree of labour market fa high degree of labour market flexibility, mechanisms for fiscal lexibility, mechanisms for fiscal transfer, and the absence of extetransfer, and the absence of external shocks that impact differenrnal shocks that impact differently on different economiestly on different economies

With trade, Crusoe’s Consumption-Possibilities CWith trade, Crusoe’s Consumption-Possibilities Curve urve （（ CPCCPC ）） can lie beyond his Production-Possican lie beyond his Production-Possibilities Curve bilities Curve （（ PPCPPC ））