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Economic Integration and the

European Union

Introduction to Economic
Forms of integration
Gains from integration

EU structures
- Institutions
- Decision making

Forms of Economic Cooperation
between Nations

Regional economic associations vs.

global efforts (WTO)

Trade liberalization vs. economic

- economic integration goes further and is
more discriminatory

Forms of Economic Association

Free trade area (FTA)

- Free trade between the members
Customs union (CU)
- FTA + common external tariffs on trade with
Common market (CM)
- CU + free mobility of factors of production
Economic union (EU)
- CM + common economic policy

Gains from Integration
Assumption: more
trade is good
More trade see International
Economics for
Stop wars! trade theories

Better use of existing resources

- specialization (comparative advantage)
- lower prices (intensified competition)
- increasing returns to scale

Greater negotiation power

- Better terms of trade

Lets consider the effects of economic

Trade effect
- trade creation and trade diversion
Pro-competitive effects
Economies of scale effects
Growth effects

Trade Effects of a Customs Union
between Two Countries
a) Country A Two small price-taking
SA countries, A and B, facing
DA increasing production costs
b) Country B
pt SB
pu a b c
pw d pB w


Q1 Q2 Q3 Q4 Q5 Q6 Q7
Trade creation a + c
Trade diversion d Trade creation g
One homogeneous product, no close substitutes. 8
Pro-Competitive Effects of a CU
If the size of a countrys market is limited
and competition imperfect, participation in a
CU will increase competition welfare
An Example:
Lets assume a monopoly market in country A, with demand
curve DA and supply SA. Then DA= AR and SA= MC
profit maximizing quantity = QA and price = pA, which is
much higher than pU.

Pro-Competitive Effects of a CU
Production Welfare changes
Producers Consumers
Monopoly - (c + d)
Perfect competition - (c + d) c+d+g+z
Pro-competition effects g+z

c d g
pU z

Economies of Scale Effects in a CU
So far we have assumed increasing production
costs in the countries forming the CU and constant
production costs in the world market

In small countries with protected national markets it

is possible that demand is not sufficiently large to
allow production plants of the most efficient size

However, access to the enlarged market of a CU

may provide the conditions for optimum size
production and opportunity for cost reductions from
exploiting economies of scale (in the real world,
much trade takes place because of economies of
scale rather than comparative advantage)

An Example
Assume existence of economies of scale in
production of a commodity x produced in Country A
The domestic demand is too small to allow the
producer to reach an efficient scale
Assume that due to restrictions in trade, exports
would not be large enough either
When Country A joins a CU, restrictions are lifted
and now there is enough demand
- For sake of convenience we assume that the CU
market allows volume of production that exactly
matches As minimum average cost

Economies of Scale Effects continued
Before customs union,
A protects domestic
production by a tariff.



Q3 Q4 Q5
Country A
Factor Mobility in Common Markets

So far we have assumed that factors of production

are immobile between countries (in CU
international trade takes place in goods and
services only)

CMs entitle the free mobility of capital and labor

between member countries

Effects of Factor Mobility in CM
The advance of integration from CU to CM
intensifies the tendency towards a single price
for each commodity (service) and a single price
for each factor of production
Common markets improve the allocation of
factors across country boundaries as well as
efficiency and welfare
- The other effects mentioned before assume
that factors of production are immobile.
However, if they can move accross borders,
economic growth increases

Institutions of EU

Council of the EU (NB! Not the same thing as

European Council!)
- Main legistalitive body comprising of ministers
- Proposes new legislation, oversees execution
- Approves commission
- Works together with council in legislative issues
Court of Justice
- Oversees that national legislation is aligned with
EU law
Democracy in EU: Parliament

Parliament has 751 members

Elected directly by citizen of each member country
every 5 years
The number of MEPs per country is proportional to
population size
- Not linearly, though, but according to degressive
proportionality: the larger the country the fewer MEPs
Most legislation has to be approved by the
parliament as well as the council (two chambers)

Democracy in EU: Council of the EU

Main decision-making body of the EU

Members of the Council are ministers from the
member countries who is sent depends on the
policy area under discussion
Chair of the council is the relevant minister of the
country holding the presidency (which rotates every
6 months)
Council members represent their home countries
and can make binding decisions on behalf of their

Democracy in EU: The Commission

Excecutive body of the EU

- Proposes legislation (c.f. national governments)
- Implements legislation
Commissioners are chosen from member countries
(and approved by the parliament)
Commissioners are not supposed to advocate
national interests

Democracy in EU: Council voting rules
New voting rules in 2014: In order for a proposal to be
- Majority of countries: 55% if acting on a proposal from the
Commission or else 72%, and
- Majority of population: 65%.
- Also, there have to be at least 4 countries voting against the
proposal (and therefore the 3 biggest countries do not have an
automatic veto right)
- Exception: sensitive topics like foreign policy and taxation
require a unanimous vote (all countries in favour).
The old Council voting rules (can be used until 2017): In
order for a proposal to be passed
- 50% (if proposal was made by the Commission) or 67% (all
other cases) of the members states,
- 74% of the voting weights, which are based on the countrys
size (Germany and France have 29, Finland only 7), and
- 62% of the EU population
EU Policies and Legislation

EU legislation supercedes national legislation

- EU wide legislation needed in order for the single market to
- E.g. differences in environmental and social policy would
distort competitive advantage, social dumping
EU policies only in sectors that affect cross borders

EU Policies

Social policy
Regional policy
Agricultural policy
Environmental policy
Competition policy
Industrial policy
Transportation policy
Trade policy (vis vis rest of the world)