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COMMON MARKET THEORY Lecture outline Ref com mkt oct08.

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Presentation on theme: "COMMON MARKET THEORY Lecture outline Ref com mkt oct08."— Presentation transcript:

1 COMMON MARKET THEORY Lecture outline Ref com mkt oct08

2 Introduction zIf add free movement of all F of P to CU, result is common market (CM) zSo far assumed F of P immobile within CU & RoW zEU more than a CU zThis is one theory that underlies the single (internal) market

3 (1) Heckscher - Ohlin (H O) theory zFactor price equalisation yoccurs with free movement of goods, even without factor movements yperfect competition assumptions! yallocation of resources efficient ylab abundant country - lab price low (K price high). Country specialises where it has a factor endowment - raising the price of lab (while scarce K falls in price as demand low) ySee handout for outline of H-O model

4 zCU & factor price equalisation ybefore formation of CU tariffs & other barriers prevented FP equalisation ypost- CU: move to FP equalisation, but not complete xnon-traded goods xNTBs ybut, if extend CU thru factor mobility, possibly achieve additional welfare benefits

5 (2) Free factor mobility zAssume 1. 1 factor (labour) mobile 2. 2 countries North (N) E.U. & South(S). E.U. S - labour abundant 3. Perfect competition

6 See diagram za) labour force in N = O N L O labour force in S = O S L O Difference in real wage(w)=W n - W S

7 real wage (w)w O N O S MP L NorthMP L South NorthSouth Wn Ws Lo

8 zb)Emigration S to N = L O L 1 Equalisation of real wage = (Wc) Workers in S attracted by higher wages to N

9 zc)Welfare gain = area ABC in EU due to reallocation as the MPL (N) > MPL (S) before migration. Thus, increased production in N > fall in production in S as lab is reallocated

10 real wage (w)w O N O S MP L NorthMP L South NorthSouth Wn Ws Lo A B C L1

11 Relevant today- EU15 v CEECs real wage (w)w O N O S MP L NorthMP L South C L1NorthSouth WcWc WcWc Wn Ws Lo A B D

12 zd)Redistribution of rewards - depends where migrant workers live & where their wages are spent yLab remaining in S receive higher real wages, while real wages fall in N yIf migrant workers reside & spend in N - Ns income rises by LoBCL1 & Ss income falls by LoACL1 yIf border workers live in S, Ns income rises by only BCD & Ss income rises by DCA

13 3Capital(K) mobility & labour immobile model zN is capital rich, K = On Ko yIn S, K = OsKo z

14 real interest rate (r%)r% O N O S MP k NorthMP k South Ko rsrs B C A rnrn Y

15 zFree movement K from N to S (where higher r%) yEquilibrium K* (move Ko to K*) yR% = r u yLikely new investment zWelfare gain area ABC

16 real interest rate (r%)r% O N O S MP k NorthMP k South Ko rsrs B C A K* rnrn Y ruru ruru

17 Tax distortions (+ see case study) zAssume (above) no tax or equal tax on K in N & S zIf tax rates on K differ, investors aim for low tax country IF zNo tax in S z50% tax on K in N (NO tax harmonisation) yMPk N shown by X-Y zNew equilibrium K1 rather than K*

18 real interest rate (r%)r% O N O S MP k NorthMP k South Ko rsrs B C A K* rnrn X Y D ruru ruru K1

19 zWelfare loss ADE, compared with optimal allocation zBUT, if tax in S > tax in N (not shown) yFurther K could flow to K rich N xIe. Flow the wrong way

20 real interest rate (r%)r% O N O S MP k NorthMP k South Ko rsrs B C A K* rnrn X Y D ruru ruru K1 E

21 (4) Conclusions z1EU wage differentials exist ynot full lab mobility ypartial welfare gain BYZA ycapital is more mobile yYou should research EU wage & interest rate (eg. 10yr bond yields) convergence over the last 20yrs - see Eurostat

22 real wage (w)w O N O S MP L NorthMP L South C L1NorthSouth WcWc WcWc Wn Ws Lo A B D Y Z X

23 z2Criticise perfect competition ywould expect dynamic effects of integration to lead to mergers z3Neglects interaction of K&L z4Second best z5Tax distortions z6 Effect of multinationals in the EU?


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