Old exams:
Question 1
Since its inception, the European Union has both expressed its commitment to multilateral
trade liberalization and signed a large number of preferential trade agreements with other
countries.
a. Name and explain one advantage and one disadvantage of multilateral trade liberalization
as compared to preferential trade liberalization.
- One advantage of multilateral trade liberalization is that trade is conducted with the most
efficient trading partner which can result in better prices. It also is less discriminatory than
preferential trade liberalization because it is open to other countries whereas preferential
trades are well preferential. A disadvantage would be that they can be quite complex and
that it can pose threats developing nations because they have to compete with stronger
economies.
b. Explain the difference between the theory of absolute advantage and the theory of
comparative advantage. Why is the latter such a powerful defense of free trade?
- The theory of comparative advantage is the ability of a country or company to produce a
particular good or service at a lower opportunity cost over the other whereas absolute
advantage is when the country has the ability to produce the goods more efficiently than the
other (absolute advantage in all the goods). Both countries can still gain something by
trading with each other. Comparative advantage is a powerful defence of free trade
because all countries benefit under all circumstances, regardless of whether their
productions are more or less productive or cost-efficient of producers of other countries.
Question 2
The founding fathers of the Economic and Monetary Union (EMU) emphasized the need for
economic convergence in the years running up to its introduction. As a result, they
introduced five convergence criteria (exchange rate, government deficit & debt, inflation
and nominal long-term interest rate)that countries had to meet before being able to join
EMU.
a. Name and explain the importance of three of these convergence criteria.
- (1)Government deficit & (2)Government Debt both fall under the government finance
area of the criteria an EU member state must have to join the EMU. Their government deficit
must be <3% GDP and their government debt must be (or approaching) <60%. Why are
these important? As government spending increasing, it aggregates demand, which can
create inflation. One way this happens is when governments run deficits, they borrow from
the capital market. However, they have to pay it back and this can slow down the economic
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,growth. Another thing as Members of the EMU, governments can default on their debts,
because the ECB cannot bail them out, which leads to the potential for contagion. The
settlement for
3% deficit is because economic growth is around 3% per year, inflation around 2% per year,
the overall debt as a % of GPD would decrease over time.
- (3)Inflation: Inflation is another area of the criteria for MS to join the EMU. In order to join
inflation must be <1.5% average lowest three. The importance of inflation is that is can have
major consequences or effects on competitiveness. For example, if Spain’s currency inflated,
the prize for Spanish goods would become gradually more expensive. Which in turn
decreases the demand for their products and in the long run their competitiveness. Along
with this, there was large difference between countries due to their wages and differences in
labor costs. In countries like Spain, Italy, Greece and Ireland the wages increased a lot faster
than wages in German and therefore they lost competitiveness.
b. To what extent does the Euro Area qualify as an Optimum Currency Area? Explain your
answer carefully.
- The Euro Area qualifies as an Optimum Currency Area because it holds some of the criteria
needed. For example, as an Optimum Currency Area, you need a degree of openness and
trade intensity. The degree of openness of the economies and mutual trade intensity
determines the level of interdependency of that economy. This means that should there be
an external shock, it would then affect all economies in a similar way, being a symmetric
shock. Monetary integration is likely to lead to trade and investments and therefore increase
the openness of Member States and the intensity of the exchanges, allowing them to
become closer towards an Optimum Currency Area and therefore qualifying as an Optimum
Currency Area. Another thing that qualifies the Euro Area as an OCA is the potential of trade
(dis)similarity and diversification. Similar economies experience similar shock in similar
ways. If they were to be more diversified, as in less dependent on single products, the
likelihood of being affected by such a shock would decrease. It is suggested that the more
countries specialize, the more they can gain from trade, therefore more integrated
markets(goods) should lead to more d differentiation and specialization.
Question 3
Policy responses to the Euro crisis have been informed by different understandings as its
root causes, and shaped by political compromises between the EU member states and its
institutions. Pick one of the policy responses to the crisis (strengthening of the stability and
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, growth pact, introduction of the macroeconomic stability procedure, creation of the banking
union, or the institutionalization of sovereign bailouts through the ESM) and explain:
a. Which cause is this policy attempting to address
- The Stability and Growth Pact (SGP) was adopted in 1997 and contained 4 elements. It
included what an ‘excessive deficit’ was. The SGP considers deficits to be excessive when
they are above 3% GDP. It has a preventative arm that is designed to encourage
governments to avoid excessive deficits. This arm has a collective discussion with over each
country’s fiscal policy with Finance Ministers in hopes to deliver budgetary discipline. There
is the corrective arm which prescribes how governments should react to a breach of the
deficit limit. Only when a country does not meet the requirements of the SGP does ECOFIN
apply warnings. And lastly is the sanctions. The response to the Euro crisis was to
strengthen the SGP. In doing this, it became a stricter policy. The
EU Commission would check whether or not countries were playing by the rule. If the deficit
exceeds 3%, the EC recommended countries be fined.
b. In what ways have political disagreements shaped the outcome of the policy?
- Due to the strictness of the policy and the fact that it became more unlikely that fines were
given to countries since the countries did not want to agree with a country receiving a fine for
political reasons and fear of consequences the rule now is that when the EC argues that the
country should get a fine, they will get the fine unless the majority in the Council disagrees.
Question 4
Competition policy has been an integral part of the European integration process since the
formation of the European Economic Community.
a. Name the two main types of anti-competitive behaviour that firms may engage in, explain
why these are problematic from the point of view of the common market, and explain how the
European Commission can address this behaviour.
- Cartels and Abuse of dominant position
- Cartels: Cartels are a part of the horizontal anti-competitive practices in which firms may
engage in. Cartels will raise prices through price setting which in turn reduces the consumer
surplus and therefore harms the customers. Gaining a firm is less than the loss to consumers
which is quite inefficient on the market. Some companies may also agree to sell the same
products and goods at different prices in different territories which creates a negative effect
on the overall welfare.
- Abuse of dominant position: the abuse of a dominant position is a vertical anti-
competitive behavior. This is when a company has so much power that is allows them to
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