Mr. Massimo M Beber Fellow in Economics Sidney Sussex College Cambridge CB2 3HU European Economics Lecture 1 Economic Integration: Definition, Measurement, and Macroeconomic Significance (Provisional Version: last updated 8 th October 2007) M.Phil. in Contemporary European Studies 2007/8 ©Massimo M Beber 2007

Lecture 1 - Objectives Key Concepts –Absolute and Comparative Advantage –International Division of Labour (Specialisation) –Payments Adjustment –Macroeconomic (Income-Expenditure) Equilibrium –The Flow of Funds Framework –Foreign Economic Policy: a Classification Key Metrics –Openness (trade, finance, migration) –Performance (growth, inflation, unemployment) –Sustainability (environmental, social, ethical)

Comparative vs Absolute Advantage England 1 worker=3 wine barrels 1 worker=6 wool bales Wage=£18 Price of Wine=£18/3=£6 Price of Wool=£18/6=£3 Relative price=2 bales per barrel Portugal 1 worker=2 wine barrels 1 worker=3 wool bales Wage=£18 Price of Wine=£18/2=£9 Price of Wool=£18/3=6 Relative price=1.5 bales per barrel

Automatic International Adjustment  Gold Outflow Trade Deficit No offsetting capital inflows    “Rules of the game” apply in the deficit country  Prices fall Money stock falls Quantity theory of money    Other countries also respect the “rules of the game”   Responsive demand, both on the export and on the import side Real Depreciation Trade Balance

Macroeconomic Equilibrium Resources –Gross Domestic Product –Imports Domestic Production GDP Uses –Domestic Absorption Private Consumption Investment Public Consumption –Exports Total Expenditure Domestic Absorption plus Net Exports

THE CIRCULAR FLOW OF INCOME Business SectorHousehold Sector Public Sector Financial Sector Foreign Sector (RoW) Total Output/Income/GDP Net Taxes Net Savings Imports Consumers’ Expenditure Public Expenditure on Goods and Services Business Investment Exports

Changes in Absorption and Trade behind GDP Growth - Euro Area 2006 Source: Commission Services (European Economy News website, October 2006

The Flow of Funds Framework Saving equals income (GDP) less consumption Private savings is disposable income less consumption Public saving is tax revenue less public expenditure National (private and public) savings is GDP (net of taxes) less consumption, less the public sector deficit National saving equals the trade balance NS = [(Y-T)-C] – (G-T) = Net Exports≈Current Balance