OCR A Level Economics: Economic integration, the EU and the WTO (H460)

This study guide covers the second part of the topic Trade policies and negotiations in the area of study The global context, from the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It teaches the stages of economic integration, trade creation and trade diversion, EU membership and the role of the WTO. Every country, firm and figure in the worked examples is invented and illustrative. Protectionism and the case for free trade have their own pages, so this page leaves them aside.

Use it with the revision notes and the practice questions. The OCR Economics hub, the checklist and the free diagnostics show where you stand. For the gains from specialisation, see specialisation and trade.

What you must be able to do

Specification wording	Where it is taught
Explain, with examples, the stages of integration: free trade areas, customs union, monetary union, economic union	Stages of integration
Evaluate the internal and external consequences, including a diagrammatic analysis of trade creation and diversion	Trade creation and diversion; Consequences
Evaluate the advantages and disadvantages of EU membership and how they vary between members	EU membership
Evaluate the role of the WTO in promoting free trade	The WTO
Evaluate the WTO’s progress and difficulties, such as agricultural disputes and trade agreements	WTO progress and difficulties

Stages of integration

Each stage adds a commitment to the one before.

Stage	What members do	Real-world example
Free trade area	Remove tariffs and quotas on each other’s goods. Each member keeps its own tariffs on outsiders.	The USMCA (the North American agreement)
Customs union	As above, plus a common external tariff (CET) on all outsiders.	The EU’s customs union
Monetary union	Customs union plus a single currency and a single central bank, which sets one interest rate.	The euro area
Economic union	Monetary union plus a single market (free movement of goods, services, capital and labour) and common policies.	The EU goes furthest, but is not a full fiscal union

Trade deflection. In a free trade area, outsiders can enter through the member with the lowest tariff. Suppose Country A charges 10% and Country B charges 40% on a machine that costs 100 outside. The landed price is 110 in A and 140 in B. Goods can be imported through A and re-exported to B, so the partners need rules of origin. A customs union avoids this problem with one CET.

Monetary union: gains. No exchange-rate costs or currency risk inside the union, and prices are easier to compare. A firm exporting 8 million a year to partners and paying a 1.8% conversion margin saves 8,000,000 × 0.018 = 144,000 a year. A credible central bank can lower inflation expectations.

Monetary union: costs. Members lose their own interest rate and exchange rate. One rate cannot suit every economy. In the invented union of X and Y the common nominal rate is 3%. Inflation is 6% in X and 0.5% in Y.

Real rate in X = 3 - 6   = -3.0%  (too loose: boom risk)
Real rate in Y = 3 - 0.5 = +2.5%  (too tight: weak demand)

Adjustment then needs wage and price flexibility, labour mobility or fiscal transfers. A shock that hits only one member, an asymmetric shock, is the hardest to absorb.

Economic union adds harmonised rules (standards, competition policy, sometimes tax and budget rules). The cost is a further loss of national sovereignty.

Trade creation and trade diversion

A customs union (or free trade area) removes tariffs inside the bloc only. This is discrimination, so it creates two opposite effects.

• Trade creation: home production that was protected is replaced by cheaper imports from a partner. Resources move to better uses, so welfare rises.
• Trade diversion: imports switch from a cheaper outsider to a dearer partner because only the partner is now tariff-free. Resources are used less efficiently, so welfare falls.

Reading the diagram. Take price as the vertical axis and quantity as the horizontal one. Sketch a downward-sloping home demand curve (D) and an upward-sloping home supply curve (S). Mark two horizontal lines: the price with the tariff (high) and the price after the union (low). Quantity demanded at each price is read off D, home output off S, and imports are the gap between them. When the price falls from the high line to the low line, four areas appear.

Area	Description	Counts as
Triangle beside S	Home output that is replaced by cheaper imports	Production effect: net gain
Triangle beside D	Extra consumption at the lower price	Consumption effect: net gain
Rectangle under the high line, left of S	Surplus that moves from home producers to consumers	Transfer
Rectangle between the two triangles	Old tariff revenue on imports. Consumers gain the part of it that is a price fall; the rest is lost	Transfer, or a loss in diversion

Worked example 1: trade creation

Country Marn makes ceramic tiles. Home demand is Qd = 300 − 4P and home supply is Qs = 20 + 2P (thousand units, price in ducats). The partner’s price is 20 ducats. Marn charges a tariff of 5 ducats a unit on all imports.

• Before the union: P = 25. Qd = 200, Qs = 70, imports = 130.
• After the union (the partner’s tiles are tariff-free at 20): Qd = 220, Qs = 60, imports = 160.
• Consumer surplus gain = 5 × 200 + ½ × 5 × 20 = 1,050.
• Producer surplus loss = 5 × 60 + ½ × 5 × 10 = 325.
• Tariff revenue lost = 5 × 130 = 650.
• Net gain = 1,050 − 325 − 650 = 75.

Check by area: production effect ½ × 5 × 10 = 25, plus consumption effect ½ × 5 × 20 = 50, total 75. Both methods agree. The revenue rectangles are transfers, so only the two triangles are a net gain.

Worked example 2: trade diversion

Marn also imports pumps. An outsider sells at 16 ducats and the partner at 19. Marn’s CET is 6 ducats a unit. The same demand and supply curves apply.

• Before: the outsider’s landed price is 16 + 6 = 22. The partner’s would be 25. Marn buys from the outsider. Qd = 212, Qs = 64, imports = 148.
• After: the partner’s price is 19, below the outsider’s landed price of 22. Imports switch to the partner. Qd = 224, Qs = 58, imports = 166.
• Consumer surplus gain = 3 × 212 + ½ × 3 × 12 = 654.
• Producer surplus loss = 3 × 58 + ½ × 3 × 6 = 183.
• Tariff revenue lost = 6 × 148 = 888.
• Net effect = 654 − 183 − 888 = −417.

Split it: the two triangles give +9 (production) and +18 (consumption), a gain of 27. But the 148 units previously bought at 16 now cost 19, so the economy pays 3 × 148 = 444 more in real resources. 27 − 444 = −417. This is trade creation (27) outweighed by diversion (444).

What decides the outcome. Diversion is worse when the gap between the partner’s price and the outsider’s price is large, and when the old external tariff was high. Creation is larger when home costs are high, demand is price elastic and the partners are efficient producers. Many unions have both effects on different goods.

Internal and external consequences

	Gains	Losses
Inside the bloc	Cheaper goods and greater choice. Economies of scale from a larger market. More competition, which pushes efficiency. Inward investment.	Inefficient producers close, with structural unemployment in some regions. Lost tariff revenue. Less national control of policy.
Outside the bloc	A larger, richer market for exporters that are competitive. Firms may invest inside the CET to avoid it (tariff jumping).	Exports lose out to partner goods (diversion). Retaliation may follow. Weaker countries have less bargaining power against a large bloc.

For evaluation, ask whether blocs are a stepping stone towards global free trade (they do liberalise trade inside) or a stumbling block (they discriminate and make multilateral deals harder). Dynamic gains such as scale economies are harder to measure than the static triangles above, but may be larger.

EU membership

The EU is a customs union with a single market, and most members use the euro. Its members share a common commercial policy and negotiate trade deals as one.

Advantages. Tariff-free access to a large market. Free movement of labour fills skill gaps. Scale economies and competition. Inward investment from firms wanting access to the whole market. Greater bargaining power with outsiders. Regional funds for poorer areas.

Disadvantages. Budget contributions. Loss of control over trade policy and, in the euro area, over interest rates and the exchange rate. Trade diversion away from cheaper outside suppliers, notably in food because of the Common Agricultural Policy (CAP). Compliance costs from common rules. Adjustment costs in uncompetitive sectors.

Variation between members. The net effect depends on:

• Size and trade dependence: a small economy sending 75% of its exports to the bloc (3 of every 4) gains more from access than a large one that trades widely.
• Net budget position: Country Alder pays 9.0bn and receives 6.0bn, a net contribution of 3.0bn. With GNI of 600bn that is 0.5% of GNI. A poorer member could be a net recipient.
• Euro membership: members with weak competitiveness cannot devalue.
• Economic structure: members with large farming sectors may gain from the CAP; manufacturing exporters gain from the single market.
• Labour flows: emigration eases unemployment but can drain skills; immigration fills gaps but pressures housing in some areas.

Judge by weighing these over the short and long run and for the group you are asked about.

The WTO

The World Trade Organization, established in 1995 as successor to the GATT, promotes freer trade in these ways:

1. A negotiating forum. Rounds cut tariffs and widen rules. Tariffs are “bound” at ceilings, so a member cannot raise them above that rate.
2. Non-discrimination. Most-favoured-nation treatment means a tariff cut offered to one member goes to all. National treatment means imports are treated like home goods once in the market. Blocs are a permitted exception.
3. Dispute settlement. Members bring complaints to panels. Losers are expected to change the measure; authorised retaliation is the backstop.
4. Transparency. Members publish and review trade policies.
5. Support for developing countries. Longer adjustment periods and technical help.

Evaluation: the WTO has no power to force a member, relies on consensus, and covers only members’ agreed commitments. Its effect is greatest where rules are clear and enforceable.

WTO progress and difficulties

Progress. Successive rounds cut tariffs on goods. The Uruguay Round created the WTO and brought agriculture and services into the rules. The Trade Facilitation Agreement, agreed in 2013, aims to speed customs procedures. In 2015 members agreed at Nairobi to phase out agricultural export subsidies.

Difficulties.

• The Doha Round, launched in 2001, has largely stalled. Decisions need consensus among a large, diverse membership.
• Agriculture is the hardest area. Rich countries protect farmers with subsidies and tariffs for political and food-security reasons. Developing countries want market access and cuts in subsidies that depress world prices. Take a rich country that pays 20 per tonne on 5 million tonnes of exports: the cost is 20 × 5 = 100 million. If this lowers the world price from 200 to 185 (a fall of 7.5%), a developing exporter selling 4 million tonnes loses 15 × 4 = 60 million. Disputes over bananas, beef and cotton have each reached the WTO.
• Regional and bilateral deals have multiplied and may divert attention from global talks.
• Since December 2019 the Appellate Body, which hears appeals, has been unable to review new appeals, so some rulings cannot be finalised.

Common errors

• Giving a free trade area one shared outside tariff, which belongs to a customs union.
• Calling a customs union good or bad without comparing the size of trade creation and trade diversion, and saying who gains and who loses.
• Counting tariff revenue transfers as net welfare gains.
• Listing EU pros and cons without saying which members, or over what time period.
• Calling the WTO a world government: it enforces rules its members agreed.

Official syllabus

OCR, A Level in Economics (H460), Version 3.0 (June 2026), for first assessment in 2021: The global context, Trade policies and negotiations.