EPOS – Master in Advanced Economics - European Economic Integration

EPOS – Master in Advanced Economics

European Economic Integration

Overview

  • Instructor: Giovanni Di Bartolomeo

  • Focus Area: European Economic Integration

  • Reference Text: Baldwin-Wyplosz’s textbook

EE-KK Diagram

  • Purpose: Analyzes the impact of integration on geographical concentration.

  • Definition: The EE-KK diagram illustrates regional shares in expenditures and industry as trade costs vary.

  • Key Components of the Model:

    • Regions: Two regions depicted—North and South.

    • Assumptions:

    • Both regions have the same technology and factor supplies (no comparative advantage).

    • Two factors of production:

      • Capital (mobile)

      • Labour (immobile)

    • Two sectors of goods:

      1. Services: Labor-intensive, freely traded.

      2. Industry: Requires capital and some labor, accompanied by transaction costs.

  • Implications:

    • North's share of capital is proportional to its share of industry.

    • Both regions share capital, indicating that the distribution of capital affects the location of industrial firms.

    • No intermediate goods, resulting in no cost linkages between sectors.

Economic Forces in the EE-KK Model

  • Agglomeration Force:

    • Demand Linkage: A larger market attracts more capital owners, enhancing economy.

    • Product Market Competition: More firms enter a larger market, increasing competition.

  • Dispersion Force:

    • Not Accounted Forces:

    • Cost linkages (due to exclusion of intermediate goods).

    • Factor market competition (due to immobility of certain factors affecting both sectors).

EE Curve Analysis

  • Notation: The EE curve is graphically represented, with axes labeled for sK (share of capital) and sE (share of expenditure).

  • Characteristics of the EE Curve:

    • Shape: Upward sloping, indicating that as the North's share of industry increases, its market grows larger relative to the South's.

    • Steepness: The EE curve is steeper than the 45-degree line, reflecting that the mobile factor (capital) constitutes only part of total expenditure.

  • Trade Costs:

    • The position of the EE line is invariant to trade costs; critical factors are the allocation of labor and capital in each region.

    • An increase in the North's labor share results in a rightward shift of the EE curve.

KK Curve Analysis

  • Notation: The KK curve is also illustrated in relation to share of capital and share of expenditure.

  • Characteristics of the KK Curve:

    • Shape: Also upward sloping and is steeper than the 45-degree line, demonstrating the home market effect.

    • Trade Costs Impact:

    • As trade costs decrease, the KK curve becomes steeper.

    • Labor Distribution: The share of labor between regions does not impact the position of the KK curve.

Locational Equilibrium in the EE-KK Diagram

  • Equilibrium Representation:

    • The intersection of the EE and KK curves (points A and B) demonstrates the locational equilibrium for production and expenditure.

    • Production shifts within the market induce expenditure shifts while vice versa is also true.

    • Starting from an alternative point, say A, shifts to B happen due to these movements.

Impact of EU Integration on EE-KK Diagram

  • Effect of European Integration:

    • Integration within the EU is shown to lower trade costs in the model.

    • The KK curve is depicted to rotate counterclockwise around the equilibrium point (1/2, 1/2) as trade costs fall.

    • Result: Increased industrial movement toward larger markets (movement from B to B’).

    • Economic Implication: The tendency for economic activities to cluster geographically can result from integration, potentially leading to complete industrial depopulation in some areas or sector-specific clustering.