CHAPTER 8REGIONAL TRADING ARRANGEMENTS

MULTIPLE CHOICE
1. The European Union is primarily intended to permit:
a
.
Countries to adopt scientific tariffs on imports
b
.
An agricultural commodity cartel within the group
c
.
The adoption of export tariffs for revenue purposes
d
.
ree movement of resources and products among member nations
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%. &hich of the following represents the stage where economic integration is most complete'
a
.
Economic union
b
.
Customs union
c
.
(onetary union
d
.
Common mar)et
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*. &hich of the following represents the stage where economic integration is least complete'
a
.
ree trade area
b
.
(onetary union
c
.
Common mar)et
d
.
Customs union
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+. Customs union theory reasons that the formation of a customs union will decrease members, real
welfare when the:
a
.
Trade diversion effect exceeds the trade creation effect
b
.
Trade production effect exceeds the trade consumption effect
c
.
Trade consumption effect exceeds the trade production effect
d Trade creation effect exceeds the trade diversion effect
.
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-. &hich economic integration scheme is solely intended to abolish trade restrictions among member
countries. while setting up common tariffs against nonmembers'
a
.
Economic union
b
.
Common mar)et
c
.
ree trade area
d
.
Customs union
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/. 0y 111% the European Union had become a full2fledged:
a
.
Economic union
b
.
(onetary union
c
.
Common mar)et
d
.
iscal union
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3. &hich device has the European Union used to e4uali5e farm2product import prices with politically
determined European Union prices. regardless of shifts in world prices'
a
.
6ariable levies
b
.
7mport 4uotas
c
.
7mport subsidies
d
.
#omestic content regulations
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8. &hich trade instrument has the European Union used to insulate its producers and consumers of
agricultural goods from the impact of changing demand and supply conditions in the rest of the world'
a
.
#omestic content regulations
b
.
6ariable import levies
c
.
6oluntary export 4uotas
d
.
9rderly mar)eting agreements
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1. Assume that the formation of a customs union turns out to include the lowest2cost world producer of
the product in 4uestion. &hich effect could not occur for the participating countries'
a
.
Trade creation2production effect
b
.
Trade creation2consumption effect
c
.
Trade diversion
d
.
"cale economies and competition
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1:. &hich organi5ation of nations permits free trade among its members in industrial goods. while each
member maintains freedom in its trade policies toward non2member countries'
a
.
European Union
b
.
0enelux
c
.
Council for (utual Economic Assistance
d
.
!orth American ree Trade Association
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11. &hich of the following organi5ations is considered a regional trading arrangement'
a
.
9rgani5ation of $etroleum Exporting Countries
b
.
!orth Atlantic Treaty 9rgani5ation
c
.
0enelux
d
.
7nternational Tin Agreement
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1%. &hen products from high2cost suppliers within a customs union replace imports from a low2cost
nation that is not a member of the customs union. there exist;s<:
a #ynamic welfare losses
.
b
.
#ynamic welfare gains
c
.
Trade creation
d
.
Trade diversion
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1*. &hich form of economic integration occurs when participating countries abolish tariffs on trade
among themselves. establish a common tariff on imports from nonmembers. and permit free
movement of capital and labor within the organi5ation'
a
.
ree trade area
b
.
Economic union
c
.
Common mar)et
d
.
(onetary union
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1+. A static welfare effect resulting from the formation of the European Union would be:
a
.
Economies of scale
b
.
Trade diversion
c
.
7nvestment incentives
d
.
7ncreased competition
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1-. A dynamic welfare gain resulting from the formation of the European Union would be:
a
.
Trade diversion
b
.
Trade creation
c
.
#iseconomies of scale
d
.
Economies of scale
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1/. &hich organi5ation was founded in 11-3 whose ob=ective was to create an economic union among its
members'
a
.
>eneral Agreements on Tariffs and Trade
b
.
9rgani5ation of Economic Cooperation and #evelopment
c
.
European Union
d
.
?atin American ree Trade Association
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13. The common agriculture policy of the European Union has supported European farmers via:
a
.
Export tariffs and domestic content regulations
b
.
6ariable levies and voluntary export agreements
c
.
Content regulations and export subsidies
d
.
Export subsidies and variable levies
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18. &hich nation is not a member of the !orth American ree Trade Association'
a
.
Canada
b
.
>reenland
c
.
(exico
d
.
United "tates
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11. "uppose a communist country agrees to pay for delivery of machinery with goods produced by the
machinery. This arrangement refers to:
a
.
Countertrade
b
.
7nternational commodity agreements
c
.
Coproduction agreements
d
.
Trade diversion
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%:. !ATA is a:
a
.
(onetary union
b
.
ree trade area
c
.
Common mar)et
d
.
Customs union
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%1. Under the European Union,s common agricultural policy. a variable import levy e4uals the:
a
.
Amount by which the EU,s support price exceeds the world price
b
.
Amount by which the world price exceeds the EU,s support price
c
.
"upport price of the EU
d
.
&orld price
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%%. (embers of the European Union find that @trade creation@ is fostered when their economies are:
a
.
Aighly competitive
b
.
Aighly noncompetitive
c
.
"mall in economic importance
d
.
>eographically distant
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%*. The European Union has achieved all of the following except:
a
.
Adopted a common fiscal policy for member nations
b
.
Established a common system of agricultural price supports
c
.
#isbanded all tariffs among its member countries
d
.
?evied common tariffs on products imported from nonmembers
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%+. &hen the United "tates. Canada. and (exico form a free trade area. and (exico begins importing a
product from Canada rather than from the lowest cost world producer.
a
.
Trade diversion occurs
b
.
Trade creation occurs
c
.
&orld welfare rises
d
.
&orld welfare falls to 5ero
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%-. &hen the formation of a free trade area results in the reduction of trade with nonmember nations in
favor of member countries. BBBB occurs.
a
.
Trade devaluation
b
.
Trade revaluation
c
.
Trade destruction
d
.
Trade diversion
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%/. &hich country is not a member of the European Union'
a
.
"pain
b
.
>ermany
c
.
rance
d
.
7celand
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%3. The implementation of the European Union has:
a
.
(ade it harder for Americans to compete against the >ermans in the 0ritish mar)et
b
.
(ade it easier for Americans to compete against the >ermans in the 0ritish mar)et
c
.
(ade it harder for Americans to compete against the Capanese in the 0ritish mar)et
d
.
(ade it easier for Americans to compete against the Capanese in the 0ritish mar)et
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%8. The common agricultural policy of the European Union has:
a
.
7ncreased American farm exports to the EU
b
.
#ecreased American farm exports to the EU
c
.
?owered the price of American farm exports to the EU
d
.
!ot affected the price of American farm exports to the EU
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%1. The implementation of a common mar)et involves all of the following except:
a
.
Elimination of trade restrictions among member countries
b
.
A common tax system and monetary union
c
.
$rohibition of restrictions on factor movements
d
.
A common tariff levied in imports from nonmembers
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*:. Under the common agricultural policy. exports of any surplus 4uantities of EU produce are encouraged
through the usage of:
a
.
6ariable levies
b
.
Export subsidies
c
.
7mport 4uotas
d
.
Countertrade
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Figure 8.1 depicts the supply and demand schedules of calculators for Greece, a "small" country that
is unable to affect the world price. Greece's supply and demand schedules of calculators are
respectively depicted by SG and G. !ssume that Greece imports calculators from either Germany or
France. Suppose Germany is the world's low"cost producer who can supply calculators to Greece at
#$% per unit, while France can supply calculators at #&% per unit.
Figure 8.1. Effects f ! Cust"s U#i#
*1. Consider igure 8.1. &ith free trade. >reece imports:
a
.
* calculators from rance
b
.
- calculators from rance
c
.
* calculators from >ermany
d
.
- calculators from >ermany
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*%. Consider to igure 8.1. Assume >reece levies a per2unit tariff of D%: on imports from both >ermany
and rance.
>reece will import:
a
.
1 calculator from >ermany
b
.
1 calculator from rance
c
.
* calculators from >ermany
d
.
* calculators from rance
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**. Consider igure 8.1. Assume >reece levies a per2unit tariff of D%: on imports from both >ermany and
rance.
As a result of the D%: tariff. >reece,s consumer surplus falls by:
a
.
D1:
b
.
D1::
c
.
D11:
d
.
D1%:
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*+. Consider igure 8.1. Assume >reece levies a per2unit tariff of D%: on imports from both >ermany and
rance.
The deadweight welfare loss to >reece. resulting from the D%: tariff. e4uals:
a
.
D%:
b
.
D+:
c
.
D/:
d
.
D8:
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*-. Eeferring to igure 8.1. suppose >reece forms a customs union with rance. >reece will import:
a
.
* calculators at a per2unit price of D*:
b
.
* calculators at a per2unit price of D+:
c
.
/ calculators at a per2unit price of D*:
d
.
/ calculators at a per2unit price of D+:
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*/. Consider igure 8.1. The value of the trade diversion effect. resulting from the >reeceFrance customs
union. e4uals:
a
.
D-
b
.
D1:
c
.
D1-
d
.
D%:
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*3. Consider igure 8.1. The value of the trade creation effect. resulting from the >reeceFrance customs
union. e4uals:
a
.
D-
b
.
D1:
c
.
D1-
d
.
D%:
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*8. Consider igure 8.1. Comparing the trade creation and trade diversion effects. the impact of the
>reeceFrance customs union on the welfare of >reece is:
a
.
A D- increase in economic welfare
b
.
A D1: increase in economic welfare
c
.
A D- decrease in economic welfare
d
.
!o change in economic welfare
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*1. Consider igure 8.1. "uppose >reece had formed a customs union with >ermany. rather than rance.
The value of the trade diversion effect would be:
a
.
Gero
b
.
D-
c
.
D1:
d
.
D1-
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+:. According to igure 8.1. the formation of a >reeceF>ermany customs union would result in:
a
.
D%: of trade diversion
b
.
D+: of trade diversion
c
.
D%: of trade creation
d D+: of trade creation
.
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+1. 7n 1181 Canada and the United "tates agreed to implement a ;an< BBBB over a ten year period.
a
.
Customs union
b
.
Common mar)et
c
.
ree trade area
d
.
Economic union
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+%. 7n the United "tates. the proposed !orth American ree Trade Agreement was generally supported by:
a
.
?abor unions
b
.
Electronics firms
c
.
Environmentalists
d
.
Citrus producers
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+*. At the (aastricht "ummit of 1111. European Union negotiators called for the pursuit of a:
a
.
ree trade area
b
.
Customs union
c
.
Common mar)et
d
.
(onetary union
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++. 0y removing discriminatory government procurement laws within the European Union. member
nations hoped to benefit from all of the following except:
a
.
EU governments could purchase from the cheapest foreign suppliers
b
.
7ncreased competition occurs as domestic firms compete with foreign firms previously
shut out of the domestic mar)et
c
.
7ndustries are restructured which permits surviving firms to achieve economies of scale
d
.
Agricultural prices fall as more farmers are allowed to produce their commodities
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+-. "uppose that government procurement liberali5ation results in the U.H. government importing
automobiles from >ermany. the low2cost EU manufacturer. Cost savings could result from all of the
following except:
a
.
Competition effect
b
.
"cale2economy effect
c
.
$rotective effect
d
.
Trade effect
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+/. "uppose that steel from Capan faces a %: percent tariff in rance and a %- percent tariff in 7taly. while
rance and 7taly maintain free trade between each other. rance and 7taly are therefore part of a ;an<:
a
.
ree trade area
b
.
Customs union
c
.
Common mar)et
d
.
Economic union
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+3. "uppose that (exico and Canada form a free2trade area and Canada begins importing steel from
(exico rather than from >ermany. There occurs:
a
.
Trade diversion
b
.
Trade creation
c
.
Trade destruction
d
.
Trade exhaustion
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+8. "uppose that (exico and Canada form a free2trade area. (exicans then decrease auto manufacturing
and increase imports of autos from Canada. while the Canadians decrease computer production and
import more computers from (exico. This is an example of:
a
.
Trade diversion
b
.
Trade creation
c
.
Trade destruction
d
.
Trade exhaustion
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+1. 7f the United "tates and Canada abolish all tariffs on each other,s goods and implement a common
tariff on goods imported from other countries. there occurs a ;an<:
a
.
ree2trade area
b
.
Customs union
c
.
Common mar)et
d
.
Economic union
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-:. "uppose that the United Hingdom and 7taly abolish all tariffs on each other,s goods and all restrictions
on movements of factors of production between them. They also implement a common protectionist
policy toward other countries. This is an example of a ;an<:
a
.
ree2trade area
b
.
Customs union
c
.
Common mar)et
d
.
Economic union
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-1. The !orth American ree Trade Agreement was expected to benefit BBBB the most.
a
.
Canada
b
.
(exico
c
.
>reenland
d
.
United "tates
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-%. The !orth American ree2Trade Agreement was most strongly opposed by U.".:
a
.
Electronics manufacturers
b
.
?abor unions
c
.
Commercial ban)s
d
.
Engineering companies
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-*. 7n the United "tates. which group was most li)ely to be hurt by the !orth American ree Trade
Agreement'
a
.
Uns)illed labor
b
.
")illed labor
c
.
9wners of capital e4uipment
d
.
9wners of financial capital
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-+. 0y =oining !ATA. the United "tates. Canada. and (exico would find their short2run welfare
decreasing due to the:
a
.
Economies of scale effect
b
.
0usiness investment effect
c
.
Trade creation effect
d
.
Trade diversion effect
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--. &hen (exico became a part of !ATA. along with Canada and the United "tates. it:
a
.
Eliminated tariffs against Canada and the United "tates but maintained them against
nonmembers
b
.
Eliminated tariffs against Canada. the United "tates. and all nonmember countries
c
.
7ncreased tariffs against Canada the United "tates. and all nonmember countries
d
.
7ncreased tariffs against Canada and the United "tates. but did not change them against
nonmember countries
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-/. 7n a centrally2planned economy:
a
.
Commercial decisions are made by independent buyers and sellers acting in their own
interest
b
.
(ar)et2determined prices are used for allocating scarce resources
c
.
$rices play a rationing role so that the availability of goods is made consistent with buyer
preferences and income
d
.
>overnment controls prices and output of goods bought and sold. with minimal
recognition given to considerations of efficiency
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-3. The failure of the centrally2planned economies was exemplified by all of the following except:
a
.
7nterest rates that were below free2mar)et levels
b
.
Consumer and producer goods of inferior 4uality
c
.
#eclining rates of economic growth
d
.
"hortages of essential goods and services
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-8. The transition of the former communist countries to mar)et economies re4uires:
a
.
7mplementation of governmental price controls
b
.
$rivati5ation of public property
c
.
Transforming competitive industries into monopolies
d
.
The sale of private industries to the government
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-1. The transition of the former communist countries to mar)et economies would li)ely result in:
a
.
The implementation of price ceilings
b
.
The implementation of price floors
c
.
$rice inflation
d
.
$rice deflation
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/:. 7n the former "oviet Union. ma=or manufacturing firms were typically:
a
.
9wned and operated by employee labor unions
b
.
9wned and operated by the government
c
.
$rivately owned. but operated by the government
d
.
$ublically owned. but operated by the private sector
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/1. The transition of the former communist countries to mar)et economies re4uires all of the following
except:
a
.
Eemoving domestic price controls
b
.
9pening economies to international competition
c
.
Establishing private property rights
d
.
Terminating the convertibility of their currencies
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/%. The former communist countries included all of the following except:
a
.
East >ermany
b
.
"oviet Union
c
.
Austria
d
.
$oland
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/*. The regional trade bloc) of the former communist countries. which lasted from 11+121111. was )nown
as the:
a
.
Eastern European Economic Area
b
.
!ordic $referential Trade Agreement
c
.
Council for (utual Economic Assistance
d
.
European 7ndustrial Cooperation Union
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/+. The economic reforms of the early 111:s that occurred in the former "oviet Union and Eastern Europe
resulted in:
a
.
The formation of the Council for (utual Economic Assistance
b
.
(ultinational firms refusing to operate in these nations
c
.
A movement from centrally2planned economies toward mar)et economies
d
.
A movement from mar)et economies toward centrally2planned economies
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/-. The transition from government2controlled prices to mar)et2determined prices in the former
communist countries would be expected to result in:
a
.
$rice stability
b
.
$rice deflation
c
.
$rice inflation
d
.
!one of the above
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//. "uppose that Canada has domestic firms that could supply its entire mar)et for radios at a price of D-:.
while U.". firms could supply radios at D+: and (exico at D*:. "uppose that Canada initially has a -:
percent tariff on imports of radios and then forms a free trade area with the United "tates. As a result.
Canada reali5es:
a
.
Trade creation. no trade diversion. and overall welfare gains
b
.
Trade creation. no trade diversion. and overall welfare losses
c
.
Trade diversion. no trade creation. and potential overall welfare losses
d
.
Trade diversion. trade creation. and potential overall welfare gains
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/3. "uppose that Canada has domestic firms that could supply its entire mar)et for radios at a price of D-:.
while U.". firms could supply radios at D+: and (exico at D*:. "uppose that Canada initially has a -:
percent tariff on imports of radios and then forms a free trade area with (exico. As a result. Canada
reali5es:
a
.
Trade creation. no trade diversion. and overall welfare gains
b
.
Trade creation. no trade diversion. and overall welfare losses
c
.
Trade diversion. no trade creation. and potential overall welfare losses
d
.
Trade diversion. trade creation. and potential overall welfare gains
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/8. As of %::%. members of the European (onetary Union agreed to replace their currencies with the:
a
.
mar)
b
.
dollar
c
.
franc
d
.
euro
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/1. The formation of the European (onetary Union is expected to entail benefits for member countries
which include all of the following except:
a
.
>reater certainty for investors within the E(U
b
.
?ower costs of transactions within the E(U
c
.
7ndependent monetary policies run by the central ban) of each member country
d
.
Enhanced competition among companies in member countries
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3:. According to the theory of optimum currency areas. a currency area has the least chance for success
when:
a
.
Countries of the currency area have differing business cycles
b
.
&or)ers have a high degree of mobility across borders of the currency area
c
.
$rices and wages can be ad=usted in response to economic disturbances
d
.
A single monetary policy affects all member countries in the same manner
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31. A main disadvantage of the European (onetary Union is that:
a
.
Each member country loses the use of monetary policy as to tool to combat recession
b
.
There is a high degree of labor mobility among the member countries
c
.
$rices are highly flexible in response to changing economic conditions
d
.
&ages are highly flexible in response to changing economic conditions
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3%. &orld welfare under a customs union
a
.
7ncreases due to a trade creation effect
b
.
#ecreases due to a trade diversion effect
c
.
#epends on the relative strength of the trade creation effect and the trade diversion effect
d
.
All of the above
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3*. A common mar)et
a
.
Allows the imposition of common external trade barriers against non2members
b
.
Eepresents less economic integration than a free trade area
c
.
#oes not permit free movement of goods among member nations
d
.
#oes not allow free movement of factors of production among nations
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3+. The gains from having an optimum currency include
a
.
$rice differentiation
b
.
?ower competition
c
.
?ower transaction costs
d
.
0oth b and c
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3-. or decades. the Eastern European countries have suffered from
a
.
&idespread price controls
b
.
Excessive competition
c
.
?ac) of enforceable property rights
d
.
0oth a and c
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TRUE$FALSE
'he figure below depicts the steel mar(et for )ortugal, a small nation that is unable to affect the world
price. !ssume that Germany and France can supply steel to )ortugal at a price of #$%% and #&%%
respectively.
Figure 8.%. Prtug!&'s Stee& M!r(et
1. Consider igure 8.%. &ith free trade. $ortugal will import %- tons of steel from >ermany at a price of
D%:: per ton.
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%. Consider igure 8.%. &ith free trade. $ortugal produces 1- tons of steel. consumes *: tons of steel. and
imports 1- tons of steel.
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*. Consider igure 8.%. 7f $ortugal levies a 1:: percent nondiscriminatory tariff on its steel imports. it
will purchase - tons of steel from rance at a price of D-:: per ton.
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+. Consider igure 8.%. 7f $ortugal forms a customs union with rance. the resulting trade2creation effect
e4uals D-::.
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-. Consider igure 8.%. 7f $ortugal forms a customs union with rance. the resulting trade2diversion
effect e4uals D+::.
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/. Consider igure 8.%. As a result of a customs union formed with rance. $ortugal,s overall welfare
rises by D1::.
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3. Consider igure 8.%. 7f $ortugal had formed a customs union with >ermany. $ortugal,s welfare would
have decreased by D-::.
A!": $T": 1
8. The European Union protects its agricultural producers from import competition by the use of tariff
rates that vary directly with world prices.
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1. Under the variable levy system of the European Union. EU farmers are protected against import
competition by tariffs that vary inversely with the world price.
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1:. Trade creation tends to more than offset trade diversion for a home country forming a customs union
with partner countries when: ;1< the tariff rate in the home country is high prior to the formation of the
customs unionI ;%< there are a large number of countries forming the customs union.
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11. 7f Chile and (exico form a free2trade agreement. the welfare of the two countries will necessarily
increase.
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1%. 7f Chile and (exico abolish all tariffs on each other,s products while maintaining their own tariffs
against other countries. these two countries have formed a customs union.
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1*. &ith a preferential trading arrangement. a group of countries agrees to unilaterally reduce tariffs
applied to imports from all countries of the world.
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1+. Economic integration is the process of eliminating restrictions on international trade. payments. and
factor mobility.
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1-. &hen a group of countries establish a free2trade area. they achieve the highest stage of economic
integration.
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1/. A free2trade area is an association of trading countries whose members agree to remove all trade
restrictions among themselves. while each member country imposes identical trade restrictions against
nonmember countries.
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13. 7f the United Hingdom and 7taly eliminate all tariffs on each other,s goods and all restrictions to factor
movements between them. and implement a uniform system of import restrictions against the rest of
the world. these countries have formed a common mar)et.
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18. The highest stage of economic integration is a monetary union.
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11. Trade creation would occur if Canada and the United "tates form a free2trade area. and Canadians then
import less steel from the United "tates while importing more steel from Capan.
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%:. "uppose that (exico and Canada form a free2trade area. The (exicans then decrease refrigerator
manufacturing and increase imports of refrigerators from Canada. while the Canadians decrease auto
manufacturing and import more autos from (exico. This is an example of trade creation.
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%1. Trade creation and trade diversion refer to the short run ;static< effects of economic integration while
economies of scale. stimulus to investment. and effects on competition refer to the long run ;dynamic<
effects.
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%%. or countries forming a customs union. the trade2creation effect represents a welfare loss and the
trade2diversion effect represents a welfare gain.
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%*. 7n the short run. (exico would reali5e overall welfare gains from becoming a member of the !orth
American ree Trade Agreement if the resulting diseconomies of scale effect more than offset the
competition effect.
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%+. Trade creation occurs when imports from a low2cost supplier outside of a customs union are replaced
by purchases from a higher2cost supplier within the union.
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%-. 7f a customs union includes the low2cost supplier of the world. there would be no adverse trade2
diversion effect that would counteract the positive trade2creation effect.
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%/. The potential for trade diversion is smaller when a custom union,s external tariff is lower rather than
higher.
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%3. 7f a customs union included all of the countries in the world. there could exist only trade creation. not
trade diversion.
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%8. The larger the si5e and the greater the number of countries in a customs union. the greater will be the
trade2diversion effect.
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%1. 9ver the long run. the formation of a customs union may yield welfare gains due to economies of
scale. greater competition. and stimulus to investment.
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*:. 0y the mid2111:s. the European Union had essentially achieved the common mar)et stage of
economic integration.
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*1. At the (aastricht "ummit of 1111. members of the European Union expressed the goal of achieving
the common mar)et stage of economic integration.
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*%. To protect its farmers from foreign competition. the European Union has utili5ed variable import levies
and export subsidies.
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**. To protect its farmers from imports of agricultural goods. the European Union has implemented tariff
rates that vary directly with world prices.
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*+. As of 111%. the European Union had achieved the monetary union stage of economic integration.
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*-. The (aastricht Treaty of 1111 established a blueprint for economic union and monetary union for
European Union members.
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*/. 7t is generally agreed that completing the common mar)et stage of integration for the European Union
contributed to overall welfare losses due to trade diversion exceeding trade creation.
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*3. >overnment procurement liberali5ation permits a country to reali5e cost savings resulting from the
trade effect. competition effect. and economies2of2scale effect.
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*8. #uring the 118:s and 111:s. the United "tates negotiated free2trade agreements with 7srael. (exico.
and Canada.
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*1. orming a free2trade agreement with the United "tates provided Canadian producers a danger and an
opportunity. The danger was that U.". producers might be more price competitive than Canadian
producersI the opportunity was that longer production runs for Canadian producers. made possible by a
free2trade agreement. would result in cost reductions due to economies of scale.
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+:. "ome trade creation was expected to occur as a result of the U.".2Canada free2trade agreement. since
Canadian exports to the United "tates and U.". exports to Canada were expected to expand at the
expense of imports from >ermany and Capan that faced trade restrictions.
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+1. !egotiating the !orth American ree Trade Agreement was relatively easy since it involved meshing
two large industrial countries with a developing country.
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+%. Critics of the !orth American ree Trade Agreement maintained that it would result in manufacturing
firms fleeing (exico,s stringent pollution2control policies and relocating in the United "tates and
Canada.
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+*. U.". labor unions argued against the !orth American ree Trade Agreement on the grounds that it
would result in U.". companies relocating in (exico in order to ta)e advantage of lower wage rates.
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++. The !orth American ree Trade Agreement was expected to provide proportionately smaller benefits
to (exico than to the United "tates or Canada.
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+-. 7n the former "oviet Union. production of capital goods was determined by the free mar)et while
consumer2goods production was determined by central planning.
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+/. The former "oviet Union was characteri5ed by central economic planning and public ownership of
manufacturing enterprises.
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+3. $ricing of consumer goods in the former "oviet Union was typically regulated by price ceilings which
led to shortages.
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+8. The transition of the former "oviet Union from a planned economy to a mar)et economy would
re4uire the elimination of price controls. the privati5ation of public property. and the promotion of
business competition.
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+1. rom the 11+:s to the 118:s. the former communist countries remained isolated from the world
economy. primarily due to different tariff systems among the former communist countries.
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-:. A political dilemma facing the former communist countries in the 111:s was that the transition from a
centrally2planned economy to a mar)et economy would result in short2run costs but long2run benefits.
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SHORT ANS)ER
1. &hat is meant by economic integration'
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The term refers to the process of eliminating restrictions on international trade. payments. and factor
input mobility.
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%. &hat factors influence the extent of trade creation and trade diversion'
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Trade creation and diversion are influenced by the degree of competitiveness that member2nation
economies have prior to formation of the customs union. the number and si5e of its members. and the
si5e of its external tariff against non2members.
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ESSA*
1. Explain the theory of optimum currency areas.
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(uch of the analysis of the benefits and costs of Europe,s common currency is based on the theory of
an optimum currency area. According to this theory. the gains to be had from sharing a currency across
countries, boundaries include more uniform pricesI lower transaction costs. greater certainty for
investors. and enhanced competition. These gains must be compared against the loss of an independent
monetary policy and the option of changing the exchange rate.
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%. Concerning transition economies. what do the advocates of shoc) therapy propose'
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Advocates of shoc) therapy maintain that economies in transition should proceed immediately on all
fronts. That is. they should privati5e. abandon price controls. liberali5e trade. and develop mar)et
institutions. and so on as 4uic)ly as possible. Although the initial economic pain may be severe. it will
subside as the transition to the mar)et economy leads to rising living standards.
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