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Case Solution of Investment in Indonesia

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1. Free Trade Area

* A free trade area eliminates all barriers to trade among member countries, but allows each country to establish its own external trade barriers. The North American Free Trade Area (NAFTA) is an imperfect example of a free trade area.

* A problem with free trade areas is the potential for trade deflection whereby non-member countries try to avoid trade barriers by initially exporting their products to a member country with low trade barriers, then re-exporting the products to a member country with high trade barriers.

* Most free trade agreements specify rules of origin, which detail the conditions under which a good is classified as a member or non-member good to try to prevent trade deflection.

2. Customs Union

* A customs union combines the elimination of barriers to internal trade among member countries with the adoption of common external trade policies toward non-members. Trade deflection is not an issue in a customs union since member countries treat non-members in a uniform manner. A current example of a customs union is the Mercosur Accord, an agreement between Argentina, Brazil, Paraguay, and Uruguay.

3. Common Market

* A common market combines the elements of a customs union with a policy that allows for the mobility of factors of production. Productivity is expected to rise in a common market because factors of production are free to locate where the returns to them are highest. The European Union is an example of a common market.

4. Economic Union

* An economic union eliminates trade barriers between member countries, establishes a common external trade policy, follows a policy of factor mobility, and coordinates economic policies of member countries. An example of an economic union is the Belgium-Luxembourg Economic Union. In addition, the European Union is currently moving toward economic union status.

5. Political Union

* A political union combines the elements of an economic union with the added feature of complete political integration. The United States, transformed from 13 separate colonies into one, is an example of a political union.

* Figure 10.3, which summarizes the five forms of economic integration, should be discussed here.

The Impact of Economic Integration on Firms

* Regional economic integration has both advantages and disadvantages for businesses. On the positive side, because the elimination of trade barriers among member countries opens up new markets, firms can gain scale economies from longer production runs. The lower costs also provide an advantage when operating in non-member countries.

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