LECTURE NOTES: ECON 1150, FALL 2013 HONORS MACROECONOMICS

PROFESSOR MCLEOD, FORDHAM UNIVERSITY

LAST UPDATE SEPTEMBER, 2013

Trade and Integration case study: Is the EU worth the

trouble? Part 1

These are lecture notes in power point format, not power point lecture notes: we do not follow the 666 rule various font guidelines outlined in the WBI’s Virtual Classroom guidelines, which I strongly endorse, instead PP is just a convenient way to make some examples available online… For some reason there is no “graph paper” template for word, some of the graphics in these notes “embed” the excel file http://class.povertylectures.com/PPFsChapter2Template.xlsx which is also available directly. I have no idea what will happen when you try to make changes in these diagrams/tables online… what is a slide rule?

In using these notes to prepare electronic (word) or homework assignments you have three options:1. Use the diagrams in this file, double click on the embedded diagrams make the

changes you want, and then paste into your word file.2. Open the spreadsheet or use words or whatever program you are using drawing

capabilities, pasting the results at pictures (“windows metafiles” in to word). If you don’t paste/special pictures, strange things can happen to you diagrams, you will see.

3. Just draw the diagrams by hand, and turn them in on paper. Colors can be helpful, but are not absolutely necessary.

About these notes:

Ireland and Greece started about the same place relative to Germany, but Ireland has more than caught up

You do not have to form an currency union and remove border crossings, to trade, but it makes trade easier…. In this example, Greece & Ireland have the same relative (but not absolute advantage). Ireland’s GDP grew very rapidly after (and before) it joined the EU, Greece’s rose for a while, then fell….

Suppose 4 countries are thinking of forming (or staying in) an economic union. Can the gains from trade hold them together? (we can think of these as “per hour” PPFs) Can all have equal wages if workers in some

countries (states) are less productive?

M France (FR)2 2 Greece (GR)1 1

1 2 3 4 F 1 2M4 DE (Germany) 4 Ireland (IE)3 32 21 1

1 2 F 1 2 3 4

Figure 2.1 shows 3 countries together in the “EU” , production is at point D and the gains from trade are shared equally among the three member countries.

M Figure 2.1: FR, DE & GR all together8 A M F7 FR B GR 1.33 1.00

6 DE 0.34 3.00

5 GR C FR 0.34 3.00

4 2 7 total3 D2 DE M: Manuf1 F: food

0 1 2 3 4 5 6 7 8 F

To show the gains from trade, Figure 2.2. is the EU sans Greece, If Germany and France try to consume 3 food on their own, at D again, they would have no labor time left to produce any manufactures…. Recall in with the EU (Fig 2.1) they had .34 units of manufactures each, even after they generously gave Greece .33 units more than it would have had on its own…..

Figure 2.2. Greece leaves, DE and FR stayM6 DE & FR consume less w/o GR:5 FR A Food Manuf4 DE 3.00 & 0.00

3 FR 3.00 & 0.00

2 DE1 D 6.0 0.0

1 2 3 4 5 6 F

Figure 2.2: note the dotted lines again, the gains from trade are greater for FR and DE because (a) they are more different as measured by the slopes of their PPFs, the opportunity cost of food in France is ½ unit of M, in DE it is 2 M, so FR should produce food as long as possible, and Germany should specialize in Machinery (M) b) they are more productive, compared to Greece one of them can produce twice as much of one of the goods, so the gains from adding Greece are much less than trading with each other.

Figure 2.2. Greece leaves, DE and FR stayM6 DE & FR consume less w/o GR:5 FR A Food Manuf4 DE 3.00 & 0.00

3 FR 3.00 & 0.00

2 DE1 D 6.0 0.0

1 2 3 4 5 6 F

Figure 2.1 Note the dotted lines, these are the potential gains from trade, by trading with FR or DE, Greece can

consume above it’s PPF, magic, but also limited, fundamentally Greece cannot consume as much as France

or DE because it’s workers are not as productive.

M Figure 2.1: FR, DE & GR all together8 A M F7 FR B GR 1.33 1.00

6 DE 0.34 3.00

5 GR C FR 0.34 3.00

4 2 7 total3 D2 DE M: Manuf1 F: food

0 1 2 3 4 5 6 7 8 F

With star performer Ireland, it is easier for all countries to have equal wages, without giving some countries an incentive to exit. Referring to Figure 2.5,

producing at point B, all have equal wages, but Germany and France take all the gains from trade, how do we know this? Can we have a case with equal wage under which everyone gains from being in the EU? Perhaps, lets try.

M Figure 2.5: FR, DE & IE, when FR & DE take all 10

9 FR M F8 FR 2 2

7 B DE 2 2

6 IE 2 2

5 IE B 6 64 M: Manuf3 F: food D2 DE DE1

0 1 2 3 4 5 6 7 8 9 10 F

Distrib

With star performer Ireland, it is easier for all countries to have equal wages, without giving some countries an incentive to exit. Referring to Figure 2.5,

producing at point B, all have equal wages, but Germany and France take all the gains from trade, how do we know this? Can we have a case with equal wage under which everyone gains from being in the EU? Perhaps, lets try.

M Figure 2.5: FR, DE & IE, when FR & DE take all 10

9 FR M F8 FR 2 2

7 B DE 2 2

6 IE 2 2

5 IE B 6 64 M: Manuf3 F: food D2 DE DE1

0 1 2 3 4 5 6 7 8 9 10 F

Distrib

With star performer Ireland, it is easier to have equal wages. Still the gains from trade are limited, the best France and Germany can do is offer Irish

workers an allocation in the shade region, in some respects in this example, the Irish are not different enough to gain from integration in Europe

M Figure 2.5: FR, DE & IE, when FR & DE take all 10 Gains from Trade9 FR region shaded M F8 FR 2 2

7 B DE 2 2

6 IE 2 2

5 IE B 6 64 M: Manuf3 F: food D2 DE DE1

0 1 2 3 4 5 6 7 8 9 10 F

Distrib

Can we have a case with equal wage under which everyone gains from being in the EU? What about producing at point C, who gains and who loses, at least compared to going it alone?

M Figure 2.5C: Do all three gain? FR, DE & IE 109 FR M: Manuf M F8 F: food FR 1.33 2.67

7 B DE 1.33 2.67

6 IE 1.33 2.67

5 IE C 4 84

3 D2 DE DE1

0 1 2 3 4 5 6 7 8 9 10 F

Distrib

First bullet point here

Second bullet point here

Third bullet point here

Food Manuf

France

Germany

Ireland 2.1 2.1

Can you find an allocation which (a) makes all countries better off and (b) involves an equal allocation of all products? Watch out, this may be impossible (there is no reason to make consp of both goods equal, people are different, the French & Irish may like food more than machines for example.

The gains from trade, specialization and exchange are there, but they are not transformative. Almost anyone (any country) can get above its PPF by trading with another (different) nation, but the gains may not be worth the trouble (the bonus comes from specialization & repetition, learning by doing, this is why factories work, trade facilitates specialization, which leads to faster TFP….).

Integration may help, but not because it facilitates trade, but because it speeds technical change and makes institutions converge, for example the EU worked for Ireland (or perhaps Ireland’s growth strategy made the EU work for it) but not for Greece, Portugal and Spain (so far).

Integration works best for people that are very different, but people (nations) that are very different may not get along, politically or socially (or what to integrate). Integration works because it puts very different people together (example in class) and because it causes convergence of institutions: Mexico and the U.S. remain very different, but post NAFTA Mexico has Walmart and Taco Bell, and we have Taco trucks and many many houses (to say nothing of Soccer, Tele novelas & UNIVISION).

Trade and Integration paradoxes and limitations:

Group A• Task 1• Task 2

Group B• Task 1• Task 2

Group C • Task 1

First bullet point here

Second bullet point here

Third bullet point here

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