ECON 330 Lecture 6 Notes From Professor

7/30/2019 ECON 330 Lecture 6 Notes From Professor

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The European Union, Economic

Consequences


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Introduction: Beginning

Introduction: (i)1951,European coal and steel community (ECSC) 6countries (Belgium, France, W. Germany, Italy, Lux. Netherl.) signed theTreaty of Paris. (ii) 1957, Treaty of Rome European EconomicCommunity (EEC) common market eliminated trade barriers (iii) 1967,European community (EC) and European parliament formed (iv) 1973

first enlargement of EC, Den UK Irel added=9 (v)1979 first election ofEuropean parliament, every 5 years since. (vi)1986 add Greece, Spain,Portugal= 12 (vii) 1992 European Union (EU) created. Treaty ofMaastricht, further forms of coop in foreign and defense policies.(viii)1995 Austria, Finland, Sweden join=15 (ix) 1999 New currency Eurolaunched, became unit of exchange for all EU except UK, Sweden and

Denmark (x) 2002 citizens of 12 Euro area countries form EuropeanMonetary Union (UMU). (xi) 2004, 10 new countries join EU =25(xii)2007 , Bulgaria, Romania join=27 (Euro Zone= 17)


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Introduction: Performance

(i) Internally, the EU has abolished trade barriers, adopted a common currency, and is striving towardconvergence of living standards. (ii) Internationally, the EU aims to bolster Europe's trade position andits political and economic weight. (iii) Because of the great differences in per capita income amongmember states (from $7,000 to $78,000) and in national attitudes toward issues like inflation, debt, andforeign trade, the EU faces difficulties in devising and enforcing common policies. (iv) Between 2004and 2007, 12 states acceded to the EU that are, in general, less advanced economically than the other15 member states. (v) Of the 12 most recent entrants, only Slovenia (1 January 2007), Cyprus andMalta (1 January 2008), Slovakia (1 January 2009), and Estonia (1 January 2011) have adopted the

euro. (vi) Following the 2008-09 global economic crisis, the EU economy saw moderate GDP growth in2010 and 2011, but a sovereign debt crisis in the euro zone intensified in 2011 and became the bloc'stop economic and political priority. (vii) Despite EU/IMF adjustment programs in Greece, Ireland, andPortugal, and consolidation measures in many other EU member states, significant risks to growthremain, including high public debt loads, aging populations, onerous regulations, and fears of debtcrisis contagion. (viii) In response, euro-zone leaders moved in 2011 to boost funding levels for thetemporary European Financial Stability Facility (EFSF) to almost $600 billion, to make loan terms morefavorable for crisis-hit countries, and to bring the permanent European Stabilization Mechanism (ESM)online in July 2012, a year earlier than originally planned. (ix) In addition, 25 of 27 EU member states

(all except the UK and Czech Republic) have indicated their intent to enact a "fiscal compact" treaty toboost long-term budgetary discipline and coordination.


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Introduction: Facts

Population: 503,824,373 (July 2010 est.) GDP $17.33trillion (2011 est.)

Growth rate: 1.6% (2011 est.)

GDP per capita: $34,500 (2011 est.) Labor Force: 228.4 million (2011 est.)

Unemployment: 9.5% (2011 est.)

Distribution of family income- Gini Index: 30.4 (2010

est.) Inflation rate: 3% (2011 est.)

Current Account Balance: -$32.72 billion (2011 est.)


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I. Consumers/Producers Surplus

1.Consumer Surplus: (i) D curve shows the highest possible price atwhich some consumers willing to purchase each unit of theproduct. (ii) A consumer willing to pay a very higher price of 3600for first unit. (2000 is market price) (iii) Consumers who would havebeen willing to buy at a higher price benefit from buying at the

market price (v)The whole area under the D curve measures thetotal value to consumers from buying this quantity of output(c+t+u) (vi) But the consumers make payments equal to (t+u) only.(vii) The net gain to consumers is the difference between the valuethat consumers place on the product and the payments they mustmake to buy the product (viii) Thus, CS =(c+t+u) (t+u)= c, the area

below D curve and above the price line (ix) If P increase1000-2000,CS increase to c+t+d (gain in Cs= t+d)


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Consumers/Producers Surplus


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National Mkt - no International Trade

2. Producers Surplus: (i) S curve shows the lowest possible price at whichsome producer is willing to supply each unit (ii) Some producer willing tosupply first unit at $400 covering the extra cost of producing and sellingthis first unit , but sell at market price ($1000) (iii) ) Producers who wouldhave been willing to supply at a lower price benefit from selling at themarket price (iv) By adding up all S curves for each unit supplied, thewhole area under S curve (z) is total cost of producing and selling thisquantity of product. (v) But the total revenue (Q xP) received byproducers is (area e+z). (vi) The net gain to producers is the differencebetween the total revenues received (e+z)) for units sold and the costs (z)that were incurred in producing the units of output (e+z)-(z) =e =PS(vii) PSis the area above the S curve and below the price line. (viii) If price

incraese 1000-2000, Ps increase =e+w+v, Gain in PS= e+w+v(-)(e)=w+v3. National Market with no International Trade: If no international trade

then equilibrium at point A with a P=2000, QS=QD=4000 MBs. Bothconsumers and producers benefit as PS=h=32m and CS=c=32m


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National Mkt No International trade


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II. Welfare Effects of Free trade, tariffs,

and Customs Union


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II. Welfare Effects of Free trade, tariffs,

and Customs Union1. Welfare Effects of Free Trade.

A=domestic economy, B=neighboring economy/ultimate partner incustoms union, C=lowest cost producer in the world (ii) B is by andlarge a lower cost producer than A selling at Pb but it cannotcompete with Cs price Pc. (iii) All of As imports of the good (gh)

originate in C and the balance of consumption (Q1)is supplied by Asdomestic producers . So The free trade price in A=Pc and CS=pchx,and Ps=L.

2. Welfare Effects of a Tariff.

(i)A imposes a protective tariff of magnitude t. (ii) Price within A isincreased by the full amount of tariff from Pc to Pt. (iii) Price inneighboring country B is, in the presence of tariff, priced at pb+twhich is still above Cs price ofPc+t or pt.


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Welfare Effects of Free trade, tariffs,

and Customs Union

(iv) As Imports therefore, come exclusively fromthe lowest cost producer C, but they are nowrestricted by the tariff to a level of ab (instead ofgh). (v) The balance of domestic consumption is

supplied by As own protected producers whoare able to Expand production behind protectivebarriers.(vi) Revenue from tariff is rectangle abjivolume of imports ab multiplied by the tariff t).

(vii) The welfare effects of a tariff are = Fall inconsumer surplus(pchbpt), increase in producersurplus,(pcgapt). Loss in CS>gain in PS. Totaldeadweight loss is 2 triangles aij and bhj.


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and Customs Union3. Welfare Effects of a Customs Union: (i) Now a customs

union between country A and B Formed. (ii) All tariffs areremoved between A and B but tariffs (t) are maintainedwith respect to ROW. (iii) Now tariff free goods from B arecheaper than the tarifed goods that originate from C. (iv)

As a result M from C (ROW) eliminated and insteadoriginate in B. Price established in A is Pb. (v) Total M =ef,part of this total cd(ab) replaces imports from C (calledtrade diversion effect of a customs union).(v) ec replacespart of domestic production called trade creation effect. ef

increases in consumption brought about by decrease inprice. (vi) Increase in CS= pbfbpt, decrease in PS=pbeapt,forgone tariff revenue abdc.


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and Customs Union(vi) the gain in CS is pbfbpt and is clearly greater than the sum

of the loss of PS=pbeapt and (+) the forgone tariff revenueabdc. (vii) compared to the situation in which A imposes atariff on imports from all sources, the customs union doesrepresent a welfare gain. As consumers in A gain access to

goods at a lower price (pb) than would be the case if tariffbarriers were imposed on all imports. (viii) However thesewelfare gains are smaller than those that would resultunder free trade. (ix) the largest benefit from As entry intothe market in this example goes to the producers and

workers of B who gain access to As market. They see theirproduction increase by an amount ef to meet the demandfrom A.


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and Customs Union(x) Compared to free trade As consumers are losers, and the

only gainers are the producers of B.(xi) Consequentlyviewed, in a strictly static way, A would only join acustoms union if it felt that in some industries it was inthe position of lowest cost producer of the member

nations. In reality this outcome does reflect the perceivedbenefits of joining the EU. (xii) The greater overall size ofthe market allows greater specialization and division oflabor. Economies become more open and trade flowsincrease. Some domestic industries are likely to decline as

imports from other member countries cut into the market,while the output of other industries increases.


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III. Economics/Costs-Benefits of a

Single CurrencyThe Economics of a Single Currency

1.The Benefits of a Single Currency: (i)Elimination of currency conversions

releasing substantial resources in the banking sector (ii) End of exchange

rate uncertainty, which should encourage trade and allow more efficient

allocation of resources within the EU through specialization and economies of

scale (iii)Participating nations can largely eliminate their holdings ofinternational currency and bullion reserves. The combined reserves of the

members of EU in 1990 was about ECU 200B, while USA with an economy

similar in size had reserves of only about ECU 40B. (iv) The creation of a

common European unit will increase the importance of European currency

in world markets. More of the worlds reserves will be held in Euros (v) EUwill be able to benefit from seigniorage (difference between costs of

production of a currency note and its value).


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Economics/Costs-Benefits of a Single

Currency2. The Costs of Single Currency: (i)Non-availability of exchange rate

policy as a means of accommodating shocks and balancing theexternal accounts. (ii) If all parts of the Union are hit similarly byan economic shock, it can be accommodated by coordinatedunion wide monetary and possibly fiscal policy. (iii) The more a

country resembles union wide average the less harmful is the lossof an exchange rate flexibility. (iv) The greater the similaritybetween the structures of all the member countries the morelikely is it that it comprises optimum currency area.

3. The degree of mobility factor also affects the desirability of acurrency union. Highly mobile labor or capital help adjustment to

a negative shock by moving quickly from the impacted region toareas where they are in higher demand. (vi) But, labor mobilitybetween nations in EU is much lower than the interstate mobilityin USA. Language and cultural factors as well as generous UEassistance tend to keep people at home.


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IV. Labor Markets in EU

Characteristics of Labor Markets in EU.

1.High Social Protection Costs Cause High Unemployment:

(i) EU committed to idea of substantial degree of social protection,guaranteeing incomes and services for those out of work , and the

principle of equal pay for equal work (ii) public expenditure on socialprotection average 22% of GDP in EU15, 35% in some North Europeancountries, but only 15% in USA and only 12% in Japan. (iii) Theseobjectives tend to lessen labor market flexibility and increaseunemployment. (iv) High level of income protection means a loss ofurgency on the part of the job seeker and leads to high unemploymentand a less flexible labor market. (v) A case can be made for the

economic efficiency of more protracted periods of unemployment,because a longer period of search should ultimately ensure bettermatch between the requirements of the vacancy and the skills of theapplicant


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2. The System of Collective Bargaining: (i) In WesternEurope most workers are covered by national wageagreements,negotiated at the industry level, as

opposed to being subject to more flexible plant orenterprise agreements more common in the USAcontext. (ii) Individual employers therefore haveremarkably little control over what they pay theirworkers, a source of labor market inflexibility

contributing to joblessness. (iii) The risingunemployment rates in EU countries favor the trendtoward decentralization, and national and industrywide bargaining are now losing ground.


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3. High Reservation Wages and Replacement Rates CauseHigh Unemployment: : (i) Reservation wage is defined asthe lowest wage that will induce an unemployed personto accept a job. (ii) The replacement rate is the percentageof take home pay that continues to be received after loss

of employment. (iii) The generous income support for theunemployed means that ajob search tends to be lesspressured . (iii) This degree of support leads to workersadopting high reservation wages. (v) In France, forexample, a married person with 2 children receives 88%

take home pay when first unemployed. (vi) Even by the60th month of unemployment , a French worker would stillreceive 83% of initial in-work take home pay.


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4. Non-wage Costs: (i) Transfers to the unemployed, the disabled, andthe elderly are generally financed by heavy pay roll taxes , sharedby the employers and the workers, (ii)The policies institute avicious cycle; rising UE pushes up the total cost of socialprotection, causing an increase in the pay roll taxes.(iii) Becausepayroll taxes are levied on a shrinking work force and mustsupport more dependents, the tax rates must rise, discouragingemployment. (vi) Combined pay roll tax on the lowest paid andleast skilled workers was about 62% with employers paying socialsecurity contributions of about 40% of gross wages and theemployees contributing an additional 22%. (vii) Thus, althoughincreases in wages themselves were moderating real cost forunskilled labor in France were about 40% higher than in USA.


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5. Fragmented Labor Markets: (i) Although the EuropeanUnion constitutes a single economic space , its labormarket is highly fragmented. (ii) Regional, national,cultural, and linguistic differences cause pockets of highunemployment to coexist with area of tight labor

demand. (iii) This fragmentation occurs within a singlemember country. Eg. UE in Northern Italys Alto Adigeregion is 3.4% whereas in Campania and Calabria in thesouth the rate is more than 25%. (iv) Within the EU as awhole even larger differences exist . Luxembourg has a

jobless rate of3.2% while Andalucia a poor region of SouthSpain, experiences 32% of unemployment. These areunusually profound differences in the absence of legalbarriers to the movement of labor.

ECON 330 Lecture 6 Notes From Professor

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