IB DP Economics: Economic integration – Revision Notes

These revision notes follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. They cover sub-topic 4.4, Economic integration. Agreements, blocs, their advantages and disadvantages, monetary union and the WTO are SL and HL. Trade creation, trade diversion and the evaluation of monetary union are HL only and are marked so. For fuller explanations, read the study guide.

Test yourself with the practice questions. The course page is the IB DP Economics hub, and the printable checklist tracks progress. For a quick check of weak areas, use the free 10-minute diagnostics. All countries and figures below are fictional.

Definitions to know

Term	Meaning
Preferential trade agreement	A deal giving partners better trade terms with each other than with outsiders
Bilateral	Between two countries
Regional	Between several countries in one area
Multilateral	Between many countries worldwide; the guide names the WTO
Free trade area	No barriers between members; each sets its own outside tariffs
Customs union	A free trade area plus a common external tariff
Common market	A customs union plus free movement of labour and capital
Monetary union	Members adopt one currency run by one central bank
Trade creation (HL only)	A switch from a high-cost domestic producer to a lower-cost partner
Trade diversion (HL only)	A switch from a low-cost outsider to a higher-cost partner
Rules of origin	Tests of where a good truly comes from, used to stop goods entering through the lowest-tariff member

The ladder of integration

Free trade area  ->  Customs union  ->  Common market  ->  Monetary union
(no internal       (+ common         (+ free movement   (+ one currency
 barriers)          external tariff)   of labour and      and central bank)
                                       capital)

Each step adds a feature and takes a little more national control. A useful memory aid is: internal barriers go, then the external tariff is shared, then factors move, then the currency is shared.

Advantages of trading blocs: quick recall

Advantage	Chain of reasoning	Evaluation point
Access to larger markets	More buyers, higher output, lower average cost	Needs enough demand and spare capacity
Freedom of labour	Workers move to where jobs are	Skills drain from the sending country
Bargaining power	One voice in multilateral talks	Members must first agree among themselves
Political stability	Strong links raise the cost of conflict	Cannot be measured easily; not guaranteed
Trade creation (HL only)	Switch to cheaper partner producer	Gain depends on cost gap

Disadvantages of trading blocs: quick recall

Disadvantage	Chain of reasoning	Evaluation point
Trade diversion (HL only)	Cheaper outsider replaced by dearer partner	Net effect depends on the size of diversion against creation
Loss of sovereignty	Common external tariff, shared rules	Some members accept it for the gains
Challenge to multilateral talks	Blocs favour insiders, so less push for global deals	Blocs can also bring large groups to the table

Method: telling creation from diversion (HL only)

1. Work out the price of each source before the bloc: cost × (1 + tariff) for imports.
2. Find the cheapest source before the bloc.
3. Work out the price of each source after the bloc: partner now has no tariff.
4. Find the cheapest source after.
5. Compare. Domestic to partner is creation. Outsider to partner is diversion.
6. For diversion, compare the real resource cost, not only the price.

Reminder example. Fictional country Brelan has a 20% tariff. Its own cost for a good is 70, partner Dorsk 64, outsider Esmar 55.

• Before: Dorsk 64 × 1.2 = 76.8. Esmar 55 × 1.2 = 66. Own 70. Cheapest is Esmar at 66.
• After: Dorsk 64, Esmar 66, own 70. Cheapest is Dorsk at 64.
• Switch from outsider to partner, so this is trade diversion.
• Resource cost rises by 64 − 55 = 9 a unit. Consumers pay 2 less (66 − 64). Tariff revenue lost is 55 × 0.20 = 11. Net = 2 − 11 = −9, which matches.

Monetary union

Advantages (HL only evaluation)	Disadvantages (HL only evaluation)
No conversion costs between members	One interest rate for all members
No exchange-rate risk	No exchange-rate adjustment after a shock
Easy price comparison, more competition	Tension if strong members must support weak ones
Credible low-inflation policy	Members cannot print money to ease their own debts

The guide gives the heading but no list for monetary union, so these are standard points. Always apply them. For example, if a shock hits only one member, the single interest rate cannot fit both that member and the rest.

A quick calculation. A firm converts 900 000 units of currency a year, losing 2% each time. The saving after union is 900 000 × 0.02 = 18 000.

The WTO

Objectives: lower trade barriers, promote fair competition, make trade rules predictable.

Functions: forum for negotiation, administering agreements, settling disputes, monitoring trade policies, technical help for developing members.

Factors limiting its influence (stated in the guide):

• Difficulty of agreement on services and on primary products.
• Unequal bargaining power between members.

Add reasons. Services are hard to negotiate because barriers are regulations, not tariffs. Primary products, especially food, touch jobs and food security. Large members can retaliate and fund legal teams, while small members often cannot.

Must-know distinctions

• Free trade area vs customs union: the common external tariff.
• Customs union vs common market: free movement of labour and capital.
• Common market vs monetary union: the shared currency.
• Trade creation vs trade diversion (HL only): the supplier you switch from, domestic or outsider.
• Bilateral vs regional vs multilateral: the number and spread of parties.
• Price effect vs resource-cost effect (HL only): consumers see prices, but efficiency depends on who produces at lowest real cost.

Exam wording and depth

The guide places agreements at AO1, blocs and monetary union at AO2, and the advantages and disadvantages at AO3. So a question using outline wants a brief account of a bloc type, and describe wants a detailed one. Explain or analyse wants a chain of cause and effect. Evaluate, discuss or to what extent wants both sides weighed and a reasoned conclusion. Match your depth to the command term, and spend your time where the marks are.

Evaluation toolkit

For any AO3 question, give both sides and then a verdict. Useful criteria are:

• The size and cost gap of the members.
• The time period: gains from scale take time, while adjustment costs arrive first.
• The stakeholder: consumers, producers, workers, government, outsiders.
• The guide’s point that benefits may not be shared equally.

Quick self-test

1. What does a customs union add to a free trade area?
2. What does a common market add to a customs union?
3. Name the multilateral body in the guide.
4. Fictional firm: fixed cost 300 000, variable cost 5 a unit. Calculate average cost at 20 000 units and at 100 000 units.
5. A bloc has a 25% tariff on outsiders. An outsider good costs 40. Calculate its price in the bloc.
6. (HL only) Define trade diversion.
7. (HL only) Own cost 80, partner 70, outsider 60, tariff 20% on all imports before the bloc. Is the switch after the bloc creation or diversion?
8. (HL only) A monetary union has two members. Inflation is 6% and 2%, with weights 50% each. Calculate the union average.
9. Give one reason why the WTO finds it hard to reach agreement on services.
10. Give one reason why a bloc might weaken multilateral negotiations.

Answers

1. One tariff on outsiders shared by all members.
2. Free movement of labour and capital.
3. The World Trade Organization.
4. (300 000 + 5 × 20 000) ÷ 20 000 = 400 000 ÷ 20 000 = 20. Then (300 000 + 5 × 100 000) ÷ 100 000 = 800 000 ÷ 100 000 = 8.
5. 40 × 1.25 = 50.
6. Buying from a dearer partner instead of a cheaper non-member, because the partner pays no tariff.
7. Before: partner 70 × 1.2 = 84, outsider 60 × 1.2 = 72, own 80, so the outsider at 72 is cheapest. After: partner 70, outsider 72, own 80, so the partner at 70 is cheapest. The switch is from outsider to partner: trade diversion. Resource cost rises by 70 − 60 = 10 a unit.
8. 0.5 × 6 + 0.5 × 2 = 4%.
9. Barriers to services are regulations, not tariffs, so they are hard to compare and trade off.
10. Members may see less need for a global deal because their main trade is already free.

Where marks are usually lost

• Crediting a free trade area with a tariff wall shared by all its members.
• Describing the WTO without linking it to the factors that limit its influence.
• Listing advantages and disadvantages with no verdict.
• Saying trade diversion always makes a member worse off, without comparing it against trade creation.
• Comparing prices only, and ignoring the resource-cost effect and lost tariff revenue (HL only).
• Writing about monetary union with no case to apply the points to.
• Using real figures that you cannot source, rather than reasoning from the idea.
• Confusing bilateral, regional and multilateral by thinking only of size, not of the number of parties.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization, February 2020. Sub-topic 4.4, Economic integration.