Cambridge International as and a level Economics Ebook

Figure 4.23 
The new Europe
ICELAND
NORWAY
SWEDEN
FINLAND
RUSSIA
UK
IRELAND
FRANCE
GERMANY
SPAIN
PORTUGAL
ITALY
DENMARK
POLAND
BELORUSSIA
UKRAINE
ROMANIA
HUNGARY
BULGARIA
AUSTRIA
GREECE
TURKEY
ALBANIA
MACEDONIA
SERBIA
BOSNIA
CROATIA
SLOVENIA
MOLDOVA
SLOVAKIA
CZECH REPUBLIC
SWITZERLAND
LUX.
BELGIUM
NETH.
LITHUANIA
LATVIA
ESTONIA
North
Atlantic
Ocean
North
Sea
Norwegian
Sea
Baltic
Sea
Black Sea
Mediterranean Sea
MALTA
CYPRUS
Bay of
Biscay
Gulf
of
Bothnia
Adriatic
Aegean
Ionian
Sea
English Channel
250 km
250 miles
European Union
European Economic
Community
1958–1985
European Community
1986–1994
European Union
1995–date
From 6 to 28
1958
Belgium
France
Germany
Italy
Luxembourg
Netherlands
1973
Denmark
Ireland
UK
1981
Greece
1986
Portugal
Spain
2008
Bulgaria
Romania
2013
Croatia
1995
Austria
Finland
Sweden
2004
Cyprus
Czech Republic
Estonia
Hungary
Latvia
Lithuania
Malta
Poland
Slovakia
Slovenia
Economic union: 
a trade bloc where there is free trade 
between member countries, a common external tariff and 
some common economic policies, which may include a 
common currency.
KEY TERM
106

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Chapter 4: The macroeconomy 
Trade diversion: 
where trade with a low-cost country 
outside a customs union is influenced by higher-cost 
products supplied from within.
KEY TERM
Figure 4.24 
Trade creation
P
1
0
Price
Q
1
Q
b
S
D
a
b
c
d
Supply of country
within trade bloc
with tariff
Supply of country
within trade bloc
without tariff
Domestic
Demand
Q
a
Q
P
Domestic
Supply
Figure 4.25 
Trade diversion
P
1
P
2
0
Price
Q
1
Q
b
S
D
a
b c
e
d
Supply of country
outside trade bloc
with tariff
Supply of country
outside trade bloc
without tariff
Supply of another
member country
Domestic
Demand
Q
a
Q
P
Domestic
Supply
members having the same currency and following all the 
same economic policies. In eff ect, the diff erent economies 
become one economy. Th
is occurred when the 13 original 
states formed the United States of America.
Trade creation and trade 
diversion
Trade creation
Membership of a trade bloc may give rise to 
trade creation
. 
Th
is occurs when the removal of tariff s allows members 
to specialise in those products in which they have a 
comparative advantage. More expensive domestic products 
can be replaced by imports from another member country 
that are lower in price. Th
e effi
cient fi rms within the trade 
bloc will be able to sell to a larger market and this may 
enable them to lower prices even further because they will 
be able to take greater advantage of economies of scale.
Trade creation: 
where high-cost domestic production is 
replaced by more eff iciently produced imports from within 
the customs union.
KEY TERM
shows the eff ect of trade creation. Before joining 
the trade bloc, the price of the product in the country is 
P
and the quantity consumed is 
Q
. Of this amount, 
Q
a
is supplied by domestic producers and 
Q
a
– 
Q
amount is 
imported. When the country joins the trade bloc, it can 
import the product without paying the tariff . Th
is pushes 
down the price to 
P
1
and the amount consumed increases 
to 
Q
1
. Consumers clearly gain from the lower price and the 
greater quantity consumed. Domestic producers lose as their 
sales fall and they gain a lower price. Th
ey may, however, be 
shift ing resources to making products that have now become 
more price competitive relative to those of member countries 
because of the removal of other tariff s. Indeed, trade creation 
permits both imports to be purchased more cheaply but 
also additional exports to be sold as other members lose 
their tariff protection. Th
e domestic government will lose 
out on tariff revenue but there is nevertheless a welfare gain. 
Th
e lower price increases consumer surplus by 
a
, 
b
, 
c
and 
d
amount. Producer surplus falls by 
a
amount and tariff
revenue by 
c
amount, giving a net gain of 
b
and 
d
amount.