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Trade Blocs and Trade Sanctions
Lecture 10


Trade Blocs


  1. Trade Bloc – promote internal free trade with members while retaining trade barriers with nonmember nations

    • Trade discrimination

    • Violates GATT and WTO principles of nondiscrimination

    • Types

      1. Free-trade area – a group of countries remove trade barriers among themselves but keep their separate barriers for outsiders

        • Example: North American Free Trade Agreement (NAFTA)

      2. Customs Union – a group of countries remove trade barriers among themselves and have a common external barriers to outsiders

        • Example: Russia, Belarus, and Kazakhstan

        • Example: The Southern Common Market (MERCOSUR) – Argentina, Brazil, Paraguay, and Uruguay

      3. Common market – a customs union that allows full freedom of factors, like capital, labor, products, and services

        • Example: European Union (EU)

      4. Economic Union – member countries unify all economic policies, like monetary, fiscal, and welfare policies

        • Example: United States

  2. Economics – trade bloc could increase the world’s welfare, because it encourages more trade

    • China’s price is PChina

    • If the United States imposes a tariff on Chinese products, then the price rises to Ptariff

    • The price of a Mexican good is PMexico

    • Note – supply functions are perfectly elastic; thus no producers' surplus

The Economics of a Trade Bloc

Economics of a Trade Bloc

    1. United States has with free trade with China

      • Consumers' surplus = a + b + c + d + e + f

      • Total welfare = a + b + c + d + e + f

    2. United States imposes a tariff on Chinese products

      • Consumers' surplus = a

      • Gov. revenue = b + d

      • Total welfare = a + b + d

      • Deadweight loss = c + e + f

    3. United States forms a free trade area with Mexico

      • Consumers' surplus = a + b + c

      • Gov. revenue = 0

      • Gain = a + b + c - (a + b + d) = c – d

      • The United States gains c but the U.S. gov. loses revenue d

      • A country gains if area c exceeds area d

        • If trading bloc partner has production costs similar to nonmember

        • The demand is more elastic; it shrinks d and expands c

      • Note – welfare loss is still d + e + f

    4. Trade diversion – trade shifts from a low-cost producer to a higher cost trade partner

      • Example - Great Britain joined the EU

      • Food prices increased 25% because trade was diverted from Australia, Canada, and New Zealand to the EU

      • England pays taxes to EU that subsidizes the EU ag. industry heavily

    5. Benefits of Trade Blocs

      1. Unifying countries increases the number of customers

        • Fosters competition and reduces prices

      2. Monopolies in individually countries compete with monopolies from member countries

      3. Competition forces firms to minimize costs and implement new technologies

      4. Enhance production specialization and efficiency

      5. Firms may have increasing scales to production

        • The larger a company is, the per unit cost become lower

        • Basis for a natural monopoly

      6. Could increase business investment; foreigners invest within trade bloc to avoid trade barriers


Examples of Trade Blocs

1. European Union (EU) - created a common market; capital, goods, labor, and services are free to move anywhere within the EU

  1. EU has 27 members as of 2012

    • Replicate the U.S. by forming a large market with one currency

    • Spur economic growth

    • Difficult for outsiders to penetrate EU markets

    • Eurozone is 17 countries use the common currency – euro

  2. Created the institutions

    1. European Parliament

    2. European Court of Justice

    3. European Central Bank

      • Frankfurt, Germany

      • Keep euro stable with low inflation rate

      • Dominates international trade

      • Euro has appreciated against the U.S. dollar until the European Debt Crisis

  3. Removed product regulations for countries

    • Greek ice cream

    • German beer purity and labeling laws

    • Belgian chocolate

    • Remove customs among EU countries, etc.

  4. EU Membership requires

    • Democracy

    • Human rights

    • Functioning market economy

    • Turkey and Croatia want to join even in 2012

  5. Benefits of euro

    1. Cheaper transaction costs; no currency conversion

    2. Reduces exchange rate uncertainty

    3. Promotes competition; regions can specialize

  6. Problems of euro

    1. Countries give up control over monetary policy

    2. Prices are higher relative to wages under the euro

    3. A central bank cannot devalue currency to stimulate economic growth

2. NAFTA – trade bloc for U.S., Canada, and Mexico

  • Started in 1994

  • Economists estimated Mexico gained the most and Canada was second

    1. Before 1980s, Mexico had a closed economy like Soviet Union

    2. Had a financial crisis in 1994 and 1995

    3. Last four presidents have been opening Mexico up to free markets and international trade

    4. NAFTA forces Mexico to be more market oriented

    5. Mexico had to relax foreign investment laws; attract U.S. investment

    6. Mexico gained from the growth in the citrus, sugar, and some agricultural industries

    7. Mexico attracted low-skill manufacturing like textiles, apparel, and auto parts

    8. Mexico opened free trade with other countries like Cuba

    9. Can slip products through Mexico and into the U.S. circumventing the U.S. trade barriers

  • Preempt – Japan

    • Japanese were heavily investing in Mexico

    • NAFTA reduce Japan’s influence

  • Talk to expand NAFTA to South American countries


Trade Sanctions

Trade Sanctions – impose punishment on a country

  1. Boycotts, restrictions, or embargoes

  2. Force a country to do something

  3. Both sides of a trade sanction are harmed

    • Reduces exports and imports for both countries

  4. Trade sanctions do not work

    1. Third party nations become the middlemen, circumventing the trade embargo

    2. Food embargoes – starve the people; leaders never go hungry

      • If country is democratic, the people can change leadership

      • If country has a dictator, it is hard to remove him

    3. Usually large countries pick on the smaller countries

      • Economic impact is smaller on large country

  5. Example

    • U.S. imposed sanctions on Cuba in 1950s

    • President Fidel Castro's communist regime

    • Outlawed trade between U.S. businesses and Communist bloc countries

    • Cuba and Mexico have free trade

    • Mexico and U.S. have free trade via NAFTA

    • Americans eat Cuban sugar


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