Question

25. How should a country decide on whether to join a common currency area? Derive the benefits and cost schedules of joining a currency union and explain why the slope of each of these curves should be the way you describe it to be. Is EU an optimal currency area?

Answer 1

We know that the optimum currency area means when two or more countries with a single currency, or different currencies having a fixed mutual exchange rate monitored and controlled by one single bank. A country wants to join in optimum currency area if the costs of doing so are lower than the benefits. The graphical presentation of costs and benefits are given below:

The diagram tells us the cost and benefits of joining monetary areas. The cost curve is showing downward sloping. It shows the relationship of countries economic stability loss from joining a fixed exchange rate area falls as the country’s economic integration with the area rises. On the same way, the benefit curve is slopes upward. It shows how the potential gain of the country from joining the currency area depends on its trading link with that region. The slopes tells us countries monetary efficiency gain from joining a fixed exchange rate area rises as the country’s economic integration with the area rises.

In the diagram, the c shows cost and B shows the benefit and H dividing the benefit and cost. In the left side of the curve cost is higher than benefit. And in the right side of H benefit is greater than the cost. In this area country can join the currency area. The point E shows that benefit and costs are equal.

The EU is a best example of currency area. They are trading with the optimum currency called Euro.