The economic theory of integration and the EU customs union in practice
Economics of Europe 2013
Lecture 2: The economic theory of integration and the EU customs union in practice
This week we shall be looking at what impact the creation of the EEC/EU customs union may have had on trade patterns. But first we need to remind ourselves a little about the economic theory of trade.
Gains from trade
Countries trade with one another either to obtain goods that for some reason they cannot produce for themselves, or to obtain goods that another country can produce relatively cheaply. Here the theory of comparative advantage, put forward by the eighteenth century British economist and parliamentarian, David Ricardo (1772-1823), provides a key insight.
Ricardo argued that even if country A can produce all goods more cheaply than country B (i.e. country A has an absolute advantage in production), nevertheless both countries will gain from trade if each exports those goods in which it has a comparative advantage in production. To give you a very simple example:
Consider two countries: Britain and America, making just two products: pottery and grain. Their production per man year is:
Table 1
Production per man year
Britain
Units of Pottery
6
or
Units of Grain
3
America
9
12
America can clearly produce both pottery and grain more cheaply than
Britain in terms of labour input i.e. it has an absolute advantage in the production of both goods.
1
But what about comparative advantage?
Since Britain can produce either 6 units of pottery or 3 units of grain per man year (or a mixture of the two), the opportunity cost of 1 unit of pottery is 3/6 (or ½) unit grain, whilst in America it is 12/9 or 11/3 units of grain. So in Britain pottery production, in terms of loss of grain, is relatively cheaper than in America. It has a comparative advantage in pottery production.
Similarly, in Britain the opportunity cost of 1 unit of grain is 6/3 or 2, and in America it is 9/12 or ¾. So America has a
Lecture 2: The economic theory of integration and the EU customs union in practice
This week we shall be looking at what impact the creation of the EEC/EU customs union may have had on trade patterns. But first we need to remind ourselves a little about the economic theory of trade.
Gains from trade
Countries trade with one another either to obtain goods that for some reason they cannot produce for themselves, or to obtain goods that another country can produce relatively cheaply. Here the theory of comparative advantage, put forward by the eighteenth century British economist and parliamentarian, David Ricardo (1772-1823), provides a key insight.
Ricardo argued that even if country A can produce all goods more cheaply than country B (i.e. country A has an absolute advantage in production), nevertheless both countries will gain from trade if each exports those goods in which it has a comparative advantage in production. To give you a very simple example:
Consider two countries: Britain and America, making just two products: pottery and grain. Their production per man year is:
Table 1
Production per man year
Britain
Units of Pottery
6
or
Units of Grain
3
America
9
12
America can clearly produce both pottery and grain more cheaply than
Britain in terms of labour input i.e. it has an absolute advantage in the production of both goods.
1
But what about comparative advantage?
Since Britain can produce either 6 units of pottery or 3 units of grain per man year (or a mixture of the two), the opportunity cost of 1 unit of pottery is 3/6 (or ½) unit grain, whilst in America it is 12/9 or 11/3 units of grain. So in Britain pottery production, in terms of loss of grain, is relatively cheaper than in America. It has a comparative advantage in pottery production.
Similarly, in Britain the opportunity cost of 1 unit of grain is 6/3 or 2, and in America it is 9/12 or ¾. So America has a