Table of contents: ..........................................................................................................2 T a bl e s an d Fi g ur e s ...................................................................2 Q 1 : Di s t i n g ui s h be t w e e n e x t e r n a l an d i n t e r n a l e c on o m i e s of s c a l e a n d us e th e s e c on c e p t s t o e x pl a i n t h e ph e n o m e n o n of i n t r a - i nd us t r y t r a d e . Ca n t h e He c k s c h e r - Oh l i n mod e l of t r a d e e x pl a i n i nt r a i n d us t r y tr a d e ? ............................................................................

2
1.1 The Distinguish between external and internal economies of scale :...........................2

Fi g ur e 1 . 1 i n th e c as e of ex t e r n a l ec on o mi e s of s c a l e. As s h ow n i n t h e f i g ur e poi n t A re p r e s e n t s t h e ma r k e t e q ui l i b ri u m, i n th e e q ui l i b ri u m poi n t t h e f i r ms a r e c omp e t i n g i n or d e r t o s el l 4 0 mi l l i on un i t s a t $1 9 a uni t . Al s o t h e upw a r d - s l opi n g s uppl y c ur v e S1 w i t c h r e pr e s e n t s th e t ot a l of s mal l i n di v i d ua l f i r ms ' v i e w s of th e ma r k e t wi t h th e d ow n w a r d - s l opi n g l on g r un a v e r a g e c os t c ur v e . T o b ri n g out poi n t s a b ou t i n t e r n a t i o n a l tr a d e , l et us i ma g i n e th a t ope n i n g up a n e w e x po r t ma r k e t s hi f t s d e ma n d out w a r d . Ea c h f i r m w o ul d re s po n d t o th e s t r on g e r d e ma n d b y r ai s i n g out p ut . If e ac h f i r m a c t e d al on e an d a f f e c t e d on l y i t s el f , th e e x t r a de m a n d w o ul d pus h th e ma r k e t up t h e s up pl y c ur v e S 1 t o a poi n t l i k e C. Ye t th e n e w e x po r t b us i n e s s ra i s e s t h e w h ol e i nd us t r y ' s out p u t and e mpl oy m e n t , br i n g i n g ad d i ti o n a l external e c on o m i e s . T hi s me a n s , i n e f f e c t , a s us t a i n e d ri g h t h a n d mov e m e n t of t h e i nd us t r y s uppl y c ur v e . T o s h ow c os t - c ut t i n g c on v e n i e n t l y , th e a v e r a g e c os t c ur v e i n c l ud i n g e x t e r n a l ec on om i e s i s us e d . De m a n d a n d s up pl y e x pa n s i on c a t c h up wi t h e a c h ot h e r at t h e n e w e q ui l i b ri u m Poi n t . .....................................................4
1.2 Economies of scale and the phenomenon of intra-industry trade: ...............................4 1.3 The Heckscher-Ohlin model of trade (Inter-Industry Trade). Can it explain intraindustry trade?......................................................................................................................6

Q 2 : Ex a mi n e th e e x t e n t a n d pa t t e r n of intrai n d us t r y tr a d e wi t hi n t h e Eur o zon e tr a d i n g a r e a . W h a t a r e t h e i mpl i c a t i on s of y o ur an a l y s i s f or tr a d e c r e a t i on wi t hi n t hi s t r a d i n g zon e ? Ex pl a i n wi t h di r e c t

r ef e r e n c e t o y our an a l y s i s of re l e v a n t e v i d e n c e an d d a t a . .................................................................................................8
2.1 Euro zone and trade creation: .......................................................................................8 2.2 Intra-Industry Trade and Euro zone:..............................................................................9 2.3 The Grubel-Lloyd Index (IIT Index) ..........................................................................11

Q 3 : Ex pl a i n wh a t y o u un d e r s t a n d b y an opt i m u m c ur r e n c y a r e a . Is Eur o - z on e an opt i ma l c ur r e n c y a r e a ? Di s c us s wi t h r ef e r e n c e t o t h e k e y th e or e t i c a l a n d e mpi r i c a l i n di c a t o r s i n c l ud i n g y ou r an a l y s i s of t h e e x t e n t a n d pa t t e r n of i n t r a - i n d us t r y tr a d e wi t hi n t h e Eur o- z on e t r a d i n g ar e a i n ( b) , an d an an a l y s i s of t h e e x t e n t of l ab o ur mob i l i t y i n Eur o- zon e ar e a . Wh a t a r e t h e i mpl i c a t i on s of t h e t h e o r e t i c a l pr e d i c t i o n s a n d e mpi r i c a l e vi d e n c e c on c e r n i n g th e f ut u r e of th e Eur o a s a s i ng l e c ur r e n c y ? Di s c us s . ..............................2 0
3.1 What is an Optimum Currency Area ..........................................................................20 3.2 Advantages and Disadvantages of an Optimum Currency Area ................................21 3.3 Labor Mobility and Optimum Currency Area ............................................................22

4 Re f e r e n c e s : .............................................................................2 3 Tables and Figures

Figure 1.1: External Economies Magnify an Expansion in a competitive Industry......................................................................... 2 Figure 2.1: the intra and extra EU-27 trade for 2009) ........................................... 9 Table 2.2: Intra-Industry Trade and GDP per capita in 2007 for EU 27........................ 12-18

Q 1 : Di s ti n g ui s h b e t w e e n e x t e r n a l a n d i n t e r n a l e c on o mi e s of s c al e a n d us e t h e s e c on c e p t s t o e x pl a i n t h e p h e n o m e n o n o f i n t r a - i n d us t r y t r a d e . C a n t h e H e c k s c h e r - O h l i n m o d e l o f t r a d e e x pl a i n i n t r a - i n d us t r y t r a d e ?
1.1 The Distinguish between external and internal economies of scale :

Paul R.Krugman (2003) estates that External economies of scale happens when the unit cost of production depends on the size of industry in general and not necessarily the size of any one firm, on the other hand The internal economies of scale is the complete opposite which means that in order for it to happen the cost of unit of production must depends on the size of an individual firm but not necessarily the industry size (Krugman & obstfeld, 2003). Figure 1.1 below demonstrates External economies of scale

External Economies Magnify an Expansion in a competitive Industry 1.1

Figure 1.1 in the case of external economies of scale. As shown in the figure point A represents the market equilibrium, in the equilibrium point the firms are competing in order to sell 40 million units at $19 a unit. Also the upward-sloping supply curve S1 witch represents the total of small individual firms' views of the market with the downward-sloping long-run a v e r a g e c o s t c u r v e . To b r i n g o u t p o i n t s a b o u t i n t e r n a t i o n a l trade, let us imagine that opening up a new export market shifts demand outward. Each firm would respond to the stronger demand by raising output. If each firm acted alone and affected only itself, the extra demand would push the market up the s u p p l y c u r v e S 1 t o a p o i n t l i k e C . Ye t t h e n e w e x p o r t b u s i n e s s raises the whole industry's output and employment, bringing additional external economies. This means, in effect, a s u s t a i n e d r i g h t - h a n d m o v e m e n t o f t h e i n d u s t r y s u p p l y c u r v e . To s h o w c o s t - c u t t i n g c o n v e n i e n t l y, t h e a v e r a g e c o s t c u r v e including external economies is used. Demand and supply expansion catch up with each other at the new equilibrium Point. Internal and External Economies of scale implications are different depending on the Industry type, An external economies of scale industry will be consisting of many small and perfectly competitive firms, However in the case of Internal economies of Scale, Firms with large size will have a cost advantage over other smaller firms which will lead to imperfectly competitive firms (Krugman & obstfeld,2003).Firms are aware that in the case of imperfect competition the price of the products can be influenced by the firm itself and more selling can be achieved only by reducing the prices. Imperfect competition happens when there are few producers of a cretin product or for industries in which the product of cretin firm is seen by consumer as strongly differentiated from those of rival firms, so each firm is considered to be a price setter (Krugman & obstfeld, 2003). 1.2 Economies of scale and the phenomenon of intraindustry trade:

The Intra-Industry Trade theory is based on three major factors, the first one is economies of scale, the second one is assumption of increasing returns to scale, and the third one is product differentiation (Krugman, 1983).

The characterization of Intra-Industry Trade is that countries import and export similar goods and products. Almost most of the intra-industry trade happens in the developed Part of the world, between countries that have very similar social and economical structure. (Helpman et al.1999). Many factors can cause the Imports and export of similar products, However it is the assumption of the consumers love for differentiation and variety that makes the demand for another variety of similar products (Helpman et al.1999). Intra-Industry Trade has many benefits. First of all the increased competition in trade will make the Prices of goods fall down, Second gains from increasing returns to scale can be achieved as the market expanded, which in return will lower the average production cost. Third in the process of economy integration Intra-Industry Trade creates less distortion than Inter-Industry Trade. The explanation for this is that a person expects more flexibility within industries than between industries, therefore smaller adjustment costs are shown in industries where Intra-Industry Trade happens. The basic Theory of Intra-Industry Trade refers to factors such as the production of differentiated products and existence of economies of Scale. The assumption of monopolistic market structure competition makes the producers of different products set their own price to maximize profits which leads to produce a different variety of goods, whereas similar products are assumed to be produced in markets where perfect competition accurse and Since consumers have a different preferences and all different products are consumed, Intra-Industry Trade will happen in the case of no trade restrictions. (Krugman & obstfeld, 2003) Some of the hypotheses of Intra-Industry Trade theory and economies of scale are presented below. 1) I n t r a - i n d u s t r y t r a d e i s e x p e c t e d t o b e h i g h e r i n industries with higher degree of economies of scale and product differentiation (Helpman et al.1999, P.168).The producers rely on economies of scale in production and they are able to specialize in a specific variety of goods to meet the consumers demand. These goods are traded for other differentiated goods. therefore, the level of Intra-Industry Trade will be increased by having more specialized goods that are produced with economies of scale

2) T h e d e g r e e o f I n t r a - I n d u s t r y T r a d e i s e x p e c t e d t o b e higher in trade between economies with high per capita income and between economies with greater similarities in per capita income(Robert C.et al .1999, P.83)Differentiated products are mostly capital intensive products, thus an increase in the income per capita will increase the production of Differentiated products in addition similar economies will have similar factors endowments, which will lead to an increase in the Horizontal Intra-Industry Trade. 3) T h e d e g r e e o f i n t r a - I n t r a - I n d u s t r y T r a d e i s e x p e c t e d to be higher in trade between larger economies and the more similar the economies are in size (Helpman et al.1999, P.205).In larger economies producers have larger markets for their products that are produced with increasing returns to scale which means that more differentiated products will be exported and this will lead to increase in the Intra-Industry Trade. In addition countries with the same size potentially can export and imports goods produced with economies of scale. In the case of different economy size the country with larger economy will be exporting more products and the smaller economical country will be forced to import all the products since they can not benefit from the economies of scale in their productions.

1.3 The Heckscher-Ohlin model of trade (Inter-Industry Trade). Can it explain intra-industry trade? The simplest way to explain the Inter-Industry trade is to understand that it represent the exchange of one kind of products produced in one industry for another type of different product produced in another industry. The basic Ricardian model is considered to be the base for the more sophisticated Heckscher-Ohlin model (Kaempfer, et al.1995) . These two Theories concentrate on the supply Side of the Trade and they based on the comparative advantage Theories. Comparative advantages happens because countries have different benefaction factors for production , which means that some countries are capital abundant and other countries are labour abundant , according to Ricardian model countries will produce goods with the lowest opportunity cost, and this is caused by

the differences in labour productivity and productions methods , in more simple words this means that the production of a good will take place in a country where it is cheap to produce and its not necessarily that this country has the cheapest production methods . The Heckscher-Ohlin model use this theory as a base and then explains how trade happens between countries when factor productivity are equal , which means that a labour-rich country will be producing labour-intensive goods and capital- Rich countries will be producing capital- intensive goods , comparative advantage based Theories indicates that the differences between two countries when it comes to endowments factors differs and the greater these endowments factors the greater is the trade between these countries . In addition the Heckscher-Ohlin model is used to explain the trade between industrialized countries and developing countries. the Developing countries usually do not have the needed technology and described as labour abundant countries so they will export labour intensive goods , the Freedom of trade without barriers will increase the demand for labourintensive goods which in return will increase the wages and reduce the unemployment rate and with time the country comparative advantage will start to alters, despite that fact still the country is considered as labour-intensive compared to other industrialized countries, the comparative advantage will start to shift to other more capital-intensive products and in the end the same developing country will start to produce more complex products a valid example for this case is South Korea(Markusen. et al. 1995) . For all the above reasons the Heckscher-Ohlin model can not explain the Intra-Industry trade and therefore new Trade theories have specialized in the Intra-Industry Trade.

Q 2 : E x a mi n e t h e e x t e n t a n d p a t t e r n of i n t r a i n d us t r y t r a d e w i t h i n t h e E u r o z o n e t r a d i n g a r e a . W h a t a r e t h e i m pl i c a t i o n s o f y o u r a n a l y s i s f or t r a d e c r e a t i on w i t hi n t h i s t r a d i n g z o n e ? E x pl a i n w i t h d i r e c t r e f e r e n c e t o y o u r a n a l y s i s of r e l e v a n t evidence and data.

2.1 Euro zone and trade creation: In 1992 the Maastricht Treaty was signed and this was the new base for Europe to arise some of the main objectives of this Treaty were to make all of Europe a common market with free movement of goods and services , capital and labour and this in return improves the economic Trade between these countries (Europa,2007) , the European union adopts no tariffs policy between its countries and unified tariffs against countries that are not part of the union which means that all the imports from other countries will have a unified tariffs , this is a clear example of a preferential trading agreement and usually the world trade organization prohibits a similar kind of agreement but the Europe zone was a different case (Krugman & Obstfeld, 2003). All this lead to Trade Creation and trade diversion between the Euro zone countries. Trade creation explains situations when two members of a custom Union such as the European Union starts to trade between each others and in this case both of these countries will benefit and gain from this trade since there are no tariffs between them on the other hand Trade diversion explains the situation when two countries of the union begins to trade between each others , while previously one of these countries

used to trade with another country out of the union because the costs were lower while trading with that country (Viner,1950). The creation of a custom union with no tariffs between the member countries and unified tariffs against other countries out of the union make it more profitable to simply trade within the union (Krugman & Obstfeld, 2003). But in order for the Union to be affective the member countries should be similar in many aspects , the member countries should have similarity in their culture , in their Gross Domestic Product , in their infrastructure etc. the explanation is that similar countries tends to trade more between each others and this explains why most of the trading is between neighboring countries ,also trade between similar closer countries will decrease the transportation and other transaction costs (Carlton & Perloff,2005 ).

2.2 Intra-Industry Trade and Euro zone: The closer the countries to each others increase the IntraIndustry Trade between these countries and on the contrary a large distance between two countries decreases the IntraIndustry Trade (Hansson 1994) The negative relationship between Intra-Industry Trade and geographical distance can be reflected by the cost of moving products from one country to another in addition Balassa & Bauwens(1988) found that when countries are part of a custom union such as the European union the share of Intra-Industry Trade will increase between these countries also having a geographical borders will increase the Intra-Industry Trade , further more In Euro zone countries with similar gross domestic product per capita , similar culture and similar linguistic area tends to have more Intra-Industry Trade between them in addition almost most of the countries in euro zone are considered as developed countries which means that they will have more Intra-Industry Trade between them (Hansson 1989) . In the case of Euro zone Intra-Industry Trade can happen under different market structures; monopolistic competition and perfect competition, In the case of Intra-Industry Trade with monopolistic competition market structure the goods produced are more industry specific than country specific .this means that the products are perfectly substituted with each other and

differentiated with increasing returns to scale therefore IntraIndustry Trade will take place in the sector of internal economies of scale with more product differentiation (Hansson 1989).However In a market with perfect competition increasing returns are assumed to be external to the firms and internal to the industry, Intra-Industry Trade will arise between countries with similarities, since they produce similar products. Thus, the two trading partners have similar factor prices which means that products can be differentiated (Hansson 1989) Figure 2.1 taken from Eurostat website followed by the table below demonstrate the intra and extra EU-27 trade, 2009 (imports plus exports, % share of total trade)

2.1(the intra and extra EU-27 trade for 2009) Extra Intra EUExtra Country EU-27 27 Country EU-27 EU-27 2,294 4,321 Denmark 40 United Kingdo m 277 323 Slovenia 11 Italy 250 336 Cyprus 2 Malta 2 2 Latvia 4 Finland 35 53 Belgium 137 Lithuania 10 15 Romania 18 Bulgaria 11 18 Hungary 30 Ireland 47 80 Austria 50 Sweden 66 114 Estonia 3 Greece 21 37 Poland 49 Germany 534 946 Portugal 19 Netherlands 243 432 Luxembourg 7 Spain 128 234 Slovakia 16 France 255 494 Czech Republi 29 10

Intra EU-27 86 26 5 9 381 50 86 151 10 152 62 26 64 127

c Source: Eurostat(ext_lt_intratrd) From the above figure and table (2.1), it is noticed that for all of the twenty seven countries Total trade within the European union is more than the total trade within other countries outside of the union which is an indicator and proof of the existence and the degree of Intra-Industry Trade between these countries

2.3 The Grubel-Lloyd Index (IIT Index) The standard measure of the Intra-Industry Trade IIT is the Grubel-Lloyd index, Grubel and Lloyd (1975) definition of IIT is when the value of exports of an industry which is exactly matched by the imports of the same industry (Grubel and Lloyd 1975, p.20). The Grubel-Lloyd index was developed from equations of intraand inter industry Trade as per below Inter-industry trade= | Xi-Mi | Intra-industry trade= (Xi+Mi) - | Xi-Mi | X represents the country exports of the industry i and M represents the country imports of industry i based on these two equations the Grubel-Lloyd index was established, this index measures to what extent the share of total trade is IntraIndustry Trade (IIT) So t = ((Xi + Mi) | Xi-Mi |)/ (Xi+Mi) Which means that t = 1 - | Xi-Mi | / (Xi+Mi) If the value of the index is zero then there is a complete specialization which means that all trade is Inter-Industry Trade and if the value of the index is one then there is only IntraIndustry Trade (Krugman,2000). In 1989 Parjanne did some studies on this index and found out two main objections which should be considered when using this index , first objection is that the index is not linear which means that for a constant increase in export (import) for a given level of import (export) the value of the index, t, is

11

diminishing. The second objection is that the index is not dependent on the absolute values of import and export since IIT is written as a fraction of the industrys total trade (Parjanne,1989). The main issue when measuring IIT is the categorical aggregation problem (Grubel &Lloyd, 1975). The statistical data can be classified and aggregated in different levels, which is one part of the problem (Hansson,1989) another part is that Differentiated products may be aggregated to the same product groups (Bowen et al ,1998). There are two main reasons why categorical aggregation happens (Parjanne, 1989). First the possibility of sub-groups with opposite signs deficit or surplus and this will lead to a trade imbalance and IIT index will be overvalued. Second depending on how important the weighted sub-groups are weighted effects may cause the IIT index to be distorted (Parjanne 1989). So if the categorical aggregation problem is ignored the IIT index will be irrelevant when it comes to understanding actual trade patterns (Bowen et al , 1998). Three to four digit levels are suitable when doing the IIT calculations and in most cases many economics stated that these will lead to approximations witch are accurate for this reason these levels mostly used in the economic studies (Parjanne1989).

Table 2.2 below was made based on information distracted from the external and intra-European union trade 2002-2007 Eurostat pocketbook which calculates the Intra-Industry Trade index for the twenty seven countries of the European Union for the year of 2007 in different industries based on the exports and imports amounts in billions for a certain industry , in addition the below table shows the Gross domestic product (GDP) per capita in Purchasing Power Standards (PPS) which is expressed in relation to the European Union (EU-27) average set to equal 100 which means that if the country GDP per Capita is higher than 100 then this country GDP per capita is higher than the EU average and vice versa , the closer the Intra-Industry trade index to one the more it represent the degree of Intra-Industry Trade in a certain industry , on the other hand the closer the Intra-Industry Trade index to Zero the more it represent the degree of Inter-Industry Trade in a certain industry .

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(Table 2.2 Intra-Industry Trade and GDP per capita in 2007 for EU 27) Country Belgium: GDP per capita in 2007 116 Industry Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Exports Imports 55.6 24.6 9 22 259.2 91.6 75.1 92.5 3.9 1 0.9 2 9.4 1 2 6.4 7.9 3.1 2.4 2.4 81.1 5 48.4 71.2 21.1 15 35 230.3 73.6 76.5 80.2 7.2 1.2 1.7 4.4 14.5 1.9 6.5 6.1 13.4 4.3 2.2 6.9 72.6 8.9 37.1 IIT Index 0.87697 0.92341 0.75000 0.77193 0.94096 0.89104 0.99077 0.92878 0.70270 0.90909 0.69231 0.62500 0.78661 0.68966 0.47059 0.97600 0.74178 0.83784 0.95652 0.51613 0.94470 0.71942 0.86784

Bulgaria: GDP per capita in 2007 40

Czech Republic GDP per capita in 2007 83

13

Other manufactured products Denmark: GDP per capita in 2007 123 Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured

27.7 23.6 13 2.9 7.6 49.4 9.8 20 19.6 86.9 43.4 20.4 23.1 855.7 134.8 481.2 239.8 2.5 0.7 0.8 1 5.6 0.5 2.4 2.7 11.1 8.7 1.7 0.7 74.9 43.2 21.4 10.3

26.7 14.3 8.1 2.5 3.6 56.7 8 25.2 23.5 167.1 50.6 33.3 83.2 591.1 98.7 285.1 207.3 3 1 0.5 1.6 8.4 1.1 4.1 3.2 12.1 5.5 1.3 5.3 45.4 8.1 23.6 13.7

0.98162 0.75462 0.76777 0.92593 0.64286 0.93120 0.89888 0.88496 0.90951 0.68425 0.92340 0.75978 0.43462 0.81711 0.84540 0.74410 0.92731 0.90909 0.82353 0.76923 0.76923 0.80000 0.62500 0.73846 0.91525 0.95690 0.77465 0.86667 0.23333 0.75478 0.31579 0.95111 0.85833

Germany: GDP per capita in 2007 116

Estonia: GDP per capita in 2007 70

Ireland: GDP per capita in 2007 148

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products Greece: GDP per capita in 2007 90 Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products 6.3 3 1.1 2.1 10.3 2.4 2.3 5.7 39.2 22.7 6.3 10.2 143.3 23.1 71.4 48.8 68 42.4 10.5 15.2 325.8 69.7 157 99 41.2 21.5 5.5 14.2 313.2 36.8 137.2 139.2 15.9 5.7 1.8 8.4 39.3 7.8 16.5 15 77.7 22.9 12.4 42.4 204.8 31.7 103.9 69.3 105.6 32.7 12.4 60.4 342.8 59.6 156.1 127.1 106.5 27.6 18.4 60.5 257.2 47.2 105.8 104.2 0.56757 0.68966 0.75862 0.40000 0.41532 0.47059 0.24468 0.55072 0.67066 0.99561 0.67380 0.38783 0.82333 0.84307 0.81460 0.82642 0.78341 0.87084 0.91703 0.40212 0.97457 0.92189 0.99713 0.87572 0.55789 0.87576 0.46025 0.38019 0.90182 0.87619 0.87078 0.85620

Spain: GDP per capita in 2007 105

France: GDP per capita in 2007 108

Italy: GDP per capita in 2007 104

15

Cyprus: GDP per capita in 2007 92

Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products

0.4 0.2 0.1 0.2 0.6 0.2 0.3 0.2 2.2 0.8 1.1 0.2 3.9 0.5 1.2 2.2 4.4 2 0.7 1.7 8.1 1.7 2.9 3.5 1.1 0.7 0.3 0.1 15.1 0.9 7.3 6.8

2 0.8 0.1 1.1 4.3 0.6 1.8 1.9 2.9 1.1 0.5 1.2 8.3 1.1 3.9 3.3 5.1 1.6 0.7 2.9 12.7 2.3 6.1 4.3 4.9 1.5 1.3 2.1 15.1 1.7 8.7 4.7

0.33333 0.40000 1.00000 0.30769 0.24490 0.50000 0.28571 0.19048 0.86275 0.84211 0.62500 0.28571 0.63934 0.62500 0.47059 0.80000 0.92632 0.88889 1.00000 0.73913 0.77885 0.85000 0.64444 0.89744 0.36667 0.63636 0.37500 0.09091 1.00000 0.69231 0.91250 0.81739

Latvia: GDP per capita in 2007 56

Lithuania: GDP per capita in 2007 59

Luxembourg: GDP per capita in 2007 275

Hungary:

16

GDP per capita in 2007 62

Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products

7.4 4.2 1.3 2 60.9 5.6 43.1 12.2 0.1 0.1 0 0 2 0.2 1.4 0.5 123.5 46.8 23.6 53.1 275 62.3 131.7 80.9 14.6 7.5 4 3.2 103 12.3 49.4 41.3 15.9

10.7 2.8 1.2 6.6 58.4 6.4 36.6 15.4 0.7 0.4 0 0.3 2.4 0.3 1.3 0.7 107.7 28.9 18.3 60.5 250.4 44.5 119.6 86.4 23.6 7.3 5.1 11.2 94.1 13 43.6 37.4 23.1

0.81768 0.80000 0.96000 0.46512 0.97904 0.93333 0.91844 0.88406 0.25000 0.40000 0.00000 0.90909 0.80000 0.96296 0.83333 0.93166 0.76354 0.87351 0.93486 0.95318 0.83333 0.95185 0.96712 0.76440 0.98649 0.87912 0.44444 0.95485 0.97233 0.93763 0.95044 0.81538

Malta: GDP per capita in 2007 76

Netherlands: GDP per capita in 2007 132

Austria: GDP per capita in 2007 124

Poland: GDP per capita in

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2007 54

Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products

9.5 2.6 3.9 86.3 7.5 41.8 37 6.7 3.2 1.8 1.7 29.4 2.7 12 14.7 4.7 0.9 1.6 1.6 24.6 1.7 10 13 2 0.9 0.7 0.4 20 2.8 9.1 8.1 4.4

7.1 4 12 94.8 15.7 43.1 36 16.4 6.3 2.1 8 40 6.4 17.6 16 10 3 1.5 5.5 40.9 5.2 19.4 16.2 4.9 1.5 1.3 2.1 18.1 2.6 8.2 7.3 8.2

0.85542 0.78788 0.49057 0.95306 0.64655 0.98469 0.98630 0.58009 0.67368 0.92308 0.35052 0.84726 0.59341 0.81081 0.95765 0.63946 0.46154 0.96774 0.45070 0.75115 0.49275 0.68027 0.89041 0.57971 0.75000 0.70000 0.32000 0.95013 0.96296 0.94798 0.94805 0.69841

Portugal: GDP per capita in 2007 79

Romania: GDP per capita in 2007 42

Slovenia: GDP per capita in 2007 88

Slovakia: GDP per capita in 2007

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68

Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products Primary products Food and beverages Crude materials Energy Manufactured goods Chemicals Machinery and vehicles Other manufactured products

1.4 0.9 2 37.7 2.1 22.8 12.8 8.6 1.2 3.8 3.6 54.2 3.8 28.1 22.3 18.8 4.3 7.7 6.8 104.3 13.6 54.3 36.4 59.1 17 8 34.1 246.2 56.9 110.1 79.2

2.2 1.3 4.7 35.5 3.8 19.4 12.3 17.3 2.8 6.2 8.3 41.7 5.8 22.8 13.1 24.5 7.9 4.4 12.3 85.9 12 43.1 30.8 95.9 38.2 14.7 42.9 337.3 52 159 126.4

0.77778 0.81818 0.59701 0.96995 0.71186 0.91943 0.98008 0.66409 0.60000 0.76000 0.60504 0.86966 0.79167 0.89587 0.74011 0.86836 0.70492 0.72727 0.71204 0.90326 0.93750 0.88501 0.91667 0.76258 0.61594 0.70485 0.88571 0.84387 0.95500 0.81828 0.77043

Finland: GDP per capita in 2007 118

Sweden: GDP per capita in 2007 125

United Kingdom: GDP per capita in 2007 116

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Q3: Explain what you understand by an optimum currency area. Is Euro-zone an optimal currency area? Discuss with reference to the key theoretical and empirical indicators including your analysis of the extent and pattern of intraindustry trade within the Euro-zone trading area in (b), and an analysis of the extent of labour mobility in Euro-zone area. What are the implications of the theoretical predictions and empirical evidence concerning the future of the Euro as a single currency? Discuss.
3.1 What is an Optimum Currency Area . Optimum Currency Area can be defined as the geographical area in which the benefits from the common mutual currency are higher for the involved country than the benefits of the local currency. in countries with common currency it will be better to deal with and overcome any external shocks in addition to more efficiently reducing the affect of these shocks (Mongelli, 2005).However in order for the countries that are part of the common currency to be able to achieve this certain prerequisites or criterias need to be obtained . Some of these criterias are the mobility of labour and capital in addition to the mobility of the factors of productions. The mobility of both the labour and capital helps to support the economic shock in the area in order to regionally distribute the asymmetric effect (Mundell,1961).another new criterias include similarities of The structure of economy in these countries in addition to the extent of trade between these countries. All these reasons and criterias are so important because countries who are members of a monetary union need to have the same reactions for any economic shock in order for the common currency to be efficient. All (Mongelli,2005; Frankel & Rose,1998) argues that the application of common currency supports to achieve the prerequisites and criterias. 20

3.2 Advantages and Disadvantages of an Optimum Currency Area W h y s h o u l d E u r o p e c o u n t r i e s b e j o i n e d a s a n E c o n o m i c a n d Mo n e t a r y Union ? Many different reasons comes to mind when thinking about this question specially in the case of Europe these reasons expands beyond economical reasons, for some countries is it also historically or politically important to join the European union for some nations , even though sometimes the economic benefits for joining are less than the political or psychological benefits but still it is important factors in fact Baldwin(2006) argues that political reasons were highly important in the creation of Euro in addition Artis(2003) explains that political reasons are as important as economical reasons . Mongelli (2005) argues that there are no measurable tests for countries that are part of an optimum currency area to benefit from this common currency. Krugman & Obstfeld(2003) offers some hints, diagrams and schedules but not a clear answer weather the Euro Zone are an efficient optimum currency area or not , in most of the cases the given analysis suggest that some countries of the euro zone might be considered as part of the optimum currency area but in general the conclusion is that euro zone does not represent an optimum currency area situation (McDowell,2006; Krugman & Obstfeld, 2003). From economic perspective the cost of using the Euro as common currency occurs at the macro level which means that in the case of economical recession or economical boom the national exchange rate fluctuations can not work as a stabilizer (Feldstein,1997). However the implication of this differs between member countries depending on the economic size of the country which affects the country influence on the world market , for instance if a small country with a small economy is using a national currency, all else equal , and where the degree of uncertainty for investment with a more risky environment increase then the country will be facing more economic risks therefore in order to try to avoid these risks smaller countries tend to adopt a more widely used currencies 21

such as the Euro in order to increase the country credibility (Baldwin, 2006). A common currency creates more economic integration in addition a common currency removes the exchange rate between member countries so these previous rates can not be floated or devalued in the future (De Nardis & Vicarelli, 2003). In addition a common currency creates a unified market where all the goods prices are denominated in the same nominal value so countries that are part of a currency union will have more trade between them and increases the economic integration (De Nardis et al. 2008). Common currency area will create more efficiency because of all the increase in competition which will lead to more efficient use of factors of productions ,resources and more specialization between countries (Micco et al.,2003).furthermore an increase of trade between common currency countries will also increase the political integration between them which on the long term will lead to more stability and peace (Rose, 2000). Baldwin(2006) argues that the increase of trade between the euro zone countries is a result of reduction of the fixed costs of introducing a new product to European market . To summarize the above , the advantages of having a common currency includes an efficient allocation of resources, an increase of political integration and for small countries with small economy an increase of country credibility and of course the main advantage will be an increase of trade , however the disadvantages of having a common currency for stronger countries will be the loss of its independent monetary policy but again these advantages and disadvantages do differ from one country to another in the case of Euro . 3.3 Labor Mobility and Optimum Currency Area . Mundell(1961) emphasized on labour mobility as a way to overcome any economic shock in countries with common currency however Mongelli(2005) argues that Labor is not mobile in the short-run and cannot therefore act as a stabilizing mechanism other than in the long-run, where mobility becomes important in order to achieve low unemployment, in addition and for the case of Europe it is well noticed that the labour does not move a lot around Europe. Despite the fact that the borders have no barrier for the mobility of labour but still there are the cultural and language barriers between the countries

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(Mongelli, 2005).Another reason for the low labour mobility within Europe is the unemployment protection laws (Huber , 2004)

4 References:

Artis,M.J.(2003) Reflections on the Optimal Currency Area (OCA) Critera in the Light of EMU International Journal of Finance and Economics, Vol. 8, No. 4, pp. 297-307 Balassa B.and Bauwens L. (1988), The Determinants of Intra-European Trade in Manufactured Goods, European Economic Review, 32, p. 1421-1437 Baldwin, R, (2006), In or Out: An Evidence based analysis of the euros effects, Centre for comparative European policy evaluation, London, U.K Bowen P., Hollander A., and Viaene J-M. (1998), Applied International Trade Analysis, Antony Rowe Ldt, Chippenham and Eastbourne Carlton, W. D., & Perloff, M. J. (2005). Modern Industrial Organization 5th ed. Harper-Collins. Boston: Pearson Addison-Wesley. De Nardis, S. and Vicarelli, C. (2003) Currency Unions and Trade: The Special Case ofEMU Review of World Economics, Vol. 139, No. 4, pp. 625-649 De Nardis, S., De Santis, R. and Vicarelli, C. (2008) The Euros Effects on Trade in a Dynamic Setting The Journal of Comparative Economics, Vol. 5, No. 1, pp. 73-85 Europa. (2007). Gateway to the European Union. Retrieved December 1, 2011 from http://europa.eu/index_en.htm

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EUROSTAT. (2009). External and intra-European Union trade 20022007. Available:http://epp.eurostat.ec.europa.eu/portal/ page/portal/external_trade/publications/statistical_year book EUROSTAT. (2010). GDP per capita in Purchasing Power Standards trade 2003to2010. Available:http://epp.eurostat.ec.europa.eu/ tgm/table.do? tab=table&plugin=1&language=en&pcode=tsieb010 EUROSTAT. (2011). International trade in goods. Available: http://epp.eurostat.ec.europa.eu/statistics_explained/in dex.php/International_trade_in_goods Feldstein, M. (1997) the Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability the Journal of Economic Perspectives, Vol.11, No. 4, pp. 23-42. Frankel J., Rose A., (1998), The Endogeneity of the Optimum Currency Areas Criteria,The Economic Journal, Vol. 108, No. 449, pp. 1009-1025. Grubel H. G. and Lloyd P.J. (1975), Intra-industry Trade: The Theory and Measurement of International Trade in Differentiated Products, Western Printing Services Ldt, London Hansson P. (1989), Intra-Industry Trade: Measurements, Determinants and Growth, Ume,Solfjrden Offset AB Hansson P. (1994), Product Quality and Vertical Product Differentiation as Determinants of Intraindustry Trade in Swedish Manufacturing, Working Paper No. 122,FIEF Helpman, Elhanan & Krugman, Paul R. (1999) Market Structure and Foreign Trade,Increasing Returns, Imperfect Competition and the International Economy.

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The MIT Press Cambridge, Massachusetts London, England

Hine, Robert C. & Greenaway, David & Milner, Chris (1999) Vertical and Horizontal Intra-Industry Trade: An Analysis of Country- and Industry-Specific Determinants Brlhart, M. & Hine, R.C. (Ed.) IntraIndustry Trade and Adjustment: The European Experience. p.70-97, Antony Rowe Ltd. Chippenham, Wiltshire, Great Britain Huber, P. (2004) Inter-regional mobility in Europe: a note in the cross-country evidence Applied Economic Letters, Vol. 11, No. 10, pp. 619-624 Krugman P.R. (2000), Rethinking International Trade, The MIT Press, Cambridge Krugman, Paul. R & Obstfeld, Maurice (2003) International Economics, Theory and Policy.Boston, Pearson Education. Inc. Krugman, Paul; New Theories of Trade among Industrial Countries, The American Economic Review, 1983, Vol 73, No 2. Markusen, J.R; Melvin, J.R.; Kaempfer, W.H; Maskus, K.E; International Trade:Theory and Evidence, McGrawHill, 1995 McDowell, M., Thom, R., Frank, R and Bernanke, B. (2006) Principles of EconomicsMcGraw-Hill Education, Berkshire. Micco, A., Stein, E. and Ordonez, G. (2003) The Currency union effect on trade: early evidence from EMU Economic Policy, Vol. 18, No. 37, pp. 315-356 Mongelli, F.P. (2005) What is European Economic and Monetary Union Telling us About the Properties of Optimum Currency Areas? Journal of Common Market Structures, Vol. 43, No. 3, pp. 607-635

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Mundell, R. (1961) A Theory of Optimum Currency Areas, The American Economic Review, Vol. 51, No. 4, pp. 657-665. Parjanne M-L. (1989), Measurement Problems in IntraIndustry Trade, The Helsinki School of Economics, Helsinki Thomas A.Pugel. (2010). International Economics 12E. Available: http://www.mhhe.com/economics/pugel12e/keygraph/gra phkey7j.html# Viner, J. (1950). The customs union issue. New York: Carnegie Endowment for International Peace.

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