EC433 Lecture 2
Stephen Kinsella
History
Budget
CU Theory
Enlargement

Last Week
EU is an economic solution to a
political Problem

Today’s Main Message
“History affects
current spending
priorities and affects
the path of economic
integration”

3 big increases in EU economic
integration
1. Formation of the Customs Union, 1958- 1986
2. Single Market program, 1986-1992
3. European Economic and Monetary Union, 1992-
present
4

Stage of No Common Factor
Common Common
Integratio Internal External +Asset
Currency Ec. Policy
n Barriers Tarrif Mobility
FTA X
CU X X
Single Mkt X X X
Monetary
X X X X
Union
Economic
X X X X X
Union

Budget

Budget Priorities
4%
6%
7%
Research Admin
42%
8% Other Aid
Regional CAP
32%

1.27%
of
GDP

Transaction Cost Ecs
For the Firm
Costs of compliance with contracts,
social conventions, supply-chain
problems.

Phases of Ec.
Integration
EMU
Integration
Common Mkt
Economic Union
Customs Union
Free Trade Area

Costs from
Fragmented
Markets
Legal,
Regulatory
Macro Costs
Costs
Source: McDonald & Dearden, pg. 44

Why is Trade good?

What is FreeTrade?
Absence of tariffs, quotas,
or other governmental
impediments to international
trade allows each country to
SO? that it can produce
specialize in the goods
cheaply and efficiently
relative to other
countries.

Trade Creation

But first...

Price, €
Supply
CS Schedule
Eq. Price, P*
Demand Schedule
Quantity,
Eq. Quantity, Q*
(Items)

Trade Creation is
“The increase in trade volume
caused by union with a lower
cost (more efficient) supplier
within the trade bloc”
––Viner, 1950

Trade Creation (High Cost to Low Cost)
P
Supply Home
Punion post tax
Pworld post tax
P*
Punion pre tax
E F G
Pworld pre tax
Demand Home
Q
B C* D

Trade Diversion (Low Cost to High Cost)
P
Supply Home
P*
Punion post tax
Pworld post tax
Punion pre tax
Pworld pre tax
Demand Home
Q
B C* D

CU Good iff
• TC > TD

€ (bn) % GDP
(a) (b) (a) (b)
Barriers to
8 9 0.2 0.3
trade
Technical Regs 57 71 2.0 2.4
Ecs. of Scale 60 61 2.0 2.4
X-inefficiency 46 46 1.6 1.6
Total 171 187 5.8 6.4
At 1985 Prices
Source: Cecchini Report, Emerson et al, 1988.

Effects of Economic
Union
1. Location Effects
2. Accumulation Effects
3. Allocation Effects

Price Dispersion
(coefficient of variation)
1985 1993 1996
% % %
21.9 15.9 15.9
Private Final Consumption
25.4 25.9 27.2
Government final cons.
12.8 14.5 13.5
Gross fixed capital formation
19.2 23.6 22.0
Construction
9.1 6.7 7.7
Machinery
20.1 16.2 16.3
GDP

Beach on the
Enlargement

If you only read one
thing...
El-Agraa, A.M., (2002), The European Union: Economics and
Policies, 6th ed., pgs. 149–164,
337.142 AGR.

Thanks