Cambridge A‑Level Economics (9708) – Globalisation: Levels of Economic Integration
1. Syllabus‑wide Checklist (AS + A‑Level)
The Cambridge syllabus contains 11 content blocks (1.1 – 11.6). The table shows which blocks are covered by these notes and what still needs to be added.
Linking each stage of integration to the Cambridge key‑concept framework helps students see the underlying economics.
Scarcity & Choice: Countries decide how much sovereignty to surrender for larger markets.
The Margin: The marginal benefit of removing an additional barrier (e.g., a tariff) is weighed against the marginal loss of policy autonomy.
Equilibrium & Efficiency: Deeper integration moves the market toward a more efficient allocation (lower transaction costs, reduced price differentials).
Role of Government: From unilateral tariff policy (FTA) to supranational institutions that set monetary, fiscal and regulatory rules (full economic union).
Progress & Development: Integration can catalyse growth, but gains are uneven – the concept of “asymmetric shocks”.
3. Stages of Economic Integration
3.1 Free Trade Area (FTA)
All internal tariffs and quantitative restrictions are removed.
Each member retains its own external tariff (ET) towards non‑members.
Rules of origin are required to prevent “trade deflection”.
Typical welfare effect: trade creation only – no diversion because external tariffs differ.
3.2 Customs Union
Internal tariffs: removed (as in an FTA).
External tariff: a single rate (Common External Tariff – CET) applied to all imports from non‑members.
Customs administration and valuation are harmonised.
Key welfare effects: trade creation vs. trade diversion (shifting from a cheaper non‑member supplier to a higher‑cost member supplier).
3.3 Monetary Union
All features of a customs union are retained.
One legal tender replaces national currencies (e.g., the euro).
Monetary policy (interest rates, money supply) is set by a supranational central bank.
Exchange‑rate risk inside the union disappears; transaction costs fall.
Fiscal policy remains national but is usually subject to convergence criteria (e.g., Maastricht criteria).
3.4 Full Economic Union
Customs union + monetary union.
Common fiscal policy: shared budget, fiscal rules, and transfers to offset asymmetric shocks.
Extensive harmonisation of regulations – competition law, labour standards, environmental protection, product standards.
Supranational institutions with legislative powers (parliament, commission, court).
“Economic citizenship”: free movement of people, services, capital and ideas across the whole union.
Figure 1 – “Ladder of Integration” showing the step‑wise addition of policy dimensions from FTA → Customs Union → Monetary Union → Full Economic Union.Figure 2 – Supply‑and‑Demand diagram illustrating the welfare effect of removing a tariff (FTA level). The shift from Pt to Pw creates a gain in consumer surplus (ΔCS) and producer surplus (ΔPS) equal to the shaded triangles.Figure 3 – AD/AS diagram for a customs union with a CET. The right‑ward shift of AD represents trade‑creation; the left‑ward shift of AS shows possible higher production costs from regulatory harmonisation.
6. Elasticity (Syllabus 1.3)
Definition: Elasticity measures the responsiveness of one variable to a change in another (e.g., %ΔQ / %ΔP).
Price elasticity of demand (PED):e = (%ΔQd) / (%ΔP). If |e| > 1 demand is elastic, |e| < 1 inelastic.
Determinants: availability of substitutes, proportion of income spent, time horizon, definition of the good.
Relevance to integration: The welfare gain from tariff removal is larger when demand is price‑elastic because quantity changes are bigger.
Quantitative illustration (AO2): Assume a good with initial price £10, demand Q = 100 – 5P. A 20 % tariff raises the price to £12.
Pre‑tariff quantity: Q₁ = 100 – 5·10 = 50.
Post‑tariff quantity: Q₂ = 100 – 5·12 = 40.
PED at £10 = (ΔQ/ΔP)·(P/Q) = (‑5)·(10/50) = –1.0 (unit‑elastic).
Removing the tariff restores price to £10, raising quantity back to 50 – a gain of 10 units.
7. Market Failure & Government Failure (Syllabus 3)
Externalities: Cross‑border pollution or over‑use of shared natural resources can be amplified by deeper integration if regulation is not harmonised.
Coordination failures: In a customs union, members may struggle to agree on a CET that reflects each country’s comparative advantage.
Government failure: Supranational bodies can suffer from regulatory capture, bureaucratic inertia, or democratic deficit – leading to sub‑optimal rules.
Link to integration: The need for common standards (e.g., product safety) is a response to market failure; the design of institutions attempts to minimise government failure.
8. Macro‑economics: AD/AS Impact (Syllabus 4)
When a customs union introduces a CET, the aggregate demand (AD) curve can shift right because of trade‑creation (higher export demand for member‑produced goods). Simultaneously, AD may shift left if trade‑diversion reduces imports from cheaper non‑members.
Regulatory harmonisation can affect aggregate supply (AS):
Positive supply shock – reduced compliance costs, economies of scale → right‑ward shift of AS.
Negative supply shock – higher labour or environmental standards increase production costs → left‑ward shift of AS.
9. Economic Growth & Development (Syllabus 5)
Potential output (Yₚ) rises through:
Economies of scale (larger market → lower average costs).
Increased foreign direct investment attracted by a stable, harmonised regulatory environment.
Technology diffusion and knowledge spill‑overs across borders.
Asymmetric shocks can offset gains: a recession in one member may not be matched by others, leading to divergent growth paths.
Evidence: The EU’s Cohesion Fund and structural‑fund transfers aim to reduce regional disparities and sustain long‑run growth.
10. Unemployment & Inflation (Syllabus 6)
Monetary union eliminates exchange‑rate adjustment as a tool for restoring competitiveness, potentially increasing structural unemployment after a negative demand shock.
Phillips‑curve trade‑off: With a common monetary policy, individual countries cannot set interest rates to target their own inflation‑unemployment combination, leading to higher unemployment in some members.
Inflation convergence: Convergence criteria force members to keep inflation within a narrow band, reducing the risk of “inflation spill‑overs”.
11. Balance of Payments (Syllabus 8)
Current account: Trade creation in an FTA or customs union improves the trade balance of members; trade diversion can worsen it if cheaper non‑member imports are replaced by higher‑cost member goods.
Financial account: A monetary union encourages capital mobility; the removal of exchange‑rate risk leads to larger intra‑union portfolio flows.
Overall BOP impact: Deeper integration tends to reduce the volatility of the current account (more stable export markets) but may increase financial‑account volatility if capital flows become highly mobile.
12. Exchange‑Rate Regimes (Syllabus 9)
Floating regime: Each country determines its own exchange rate; compatible with an FTA but not with a monetary union.
Fixed or pegged regime: Countries maintain a predetermined parity; useful for customs unions that wish to minimise exchange‑rate fluctuations without sharing a currency.
Monetary union: De facto a fixed regime – the exchange rate is 1:1 across members because a single currency is used.
Full economic union: The exchange‑rate regime is embedded in the common monetary policy; fiscal coordination helps manage external imbalances.
13. Key Economic Implications (AO3 Evaluation)
Advantages of Deeper Integration
Economies of scale: Larger integrated markets lower average costs (e.g., EU automotive sector).
Price stability & lower transaction costs: A single currency eliminates exchange‑rate risk (Eurozone).
Increased foreign direct investment: Harmonised regulations reduce uncertainty for investors.
Policy coordination: Common fiscal rules can prevent a “race to the bottom” in taxation or labour standards.
Enhanced bargaining power: A bloc can negotiate trade agreements on behalf of all members.
Disadvantages / Risks
Loss of monetary sovereignty: No independent de‑valuation to restore competitiveness (e.g., Greece in the Eurozone).
Asymmetric shocks: A recession in one member cannot be offset by exchange‑rate adjustments, leading to higher unemployment.
Fiscal constraints: Convergence criteria and fiscal rules may force austerity even when stimulus is needed.
Political & sovereignty concerns: Transfer of decision‑making to supranational bodies can be perceived as eroding national identity.
Loss of seigniorage: Revenue from issuing currency shifts to the central bank of the union.
Real‑World Evidence
Trade creation in USMCA: intra‑regional trade rose from ~10 % to ~30 % of total trade between 1994 and 2015 (World Bank).
Trade diversion in the early EU customs union: imports of high‑quality cheese from non‑EU producers fell despite lower world prices because the CET favoured EU producers.
Eurozone crisis (2009‑2014): Ireland and Portugal experienced deep recessions while unable to de‑value, illustrating the cost of monetary union without full fiscal integration.
EU Cohesion Fund and Structural Funds: fiscal transfers that help less‑developed regions adjust to integration, demonstrating the role of a common fiscal policy in a full economic union.
14. Exam‑style Question & Structured Answer
Question: “Explain why a country might be reluctant to join a monetary union even if it already belongs to a customs union.”
Answer outline (AO2/AO3):
Loss of independent monetary policy
Cannot set interest rates or control money supply to suit domestic inflation or growth.
Example: The United Kingdom would have lost the Bank of England’s ability to target inflation after adopting the euro.
Exposure to asymmetric shocks
Without exchange‑rate flexibility, a country hit by a negative demand shock cannot de‑value to regain competitiveness.
Evidence: Greece’s prolonged recession during the Eurozone crisis.
Fiscal constraints & convergence criteria
Must meet limits on deficit, debt, inflation, long‑term interest rates (e.g., Maastricht criteria).
Domestic fiscal policy may be forced into austerity, limiting counter‑cyclical spending.
Political & sovereignty considerations
Decision‑making on monetary policy moves to a supranational central bank.
Public opposition can be strong (referendums in Denmark, Sweden, and the UK).
Potential loss of seigniorage revenue
Profit from issuing currency would go to the union’s central bank rather than the national treasury.
Conclude by weighing these drawbacks against benefits such as elimination of exchange‑rate risk, lower transaction costs, deeper market integration, and greater political influence – the typical “evaluate” approach required for full marks.
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