Understanding Economics

6th edition
by Mark Lovewell

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Understanding
Economics
6th edition
by Mark Lovewell

Chapter 15
Foreign Trade
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Learning Objectives
After this chapter you will be able to:
1. identify Canadas foreign trade, trade

relationships, and trading patterns

2. understand the case for trade, based on
absolute and comparative advantage
3. analyze the impact of trade protection and
the arguments for and against it
4. outline Canadas trade policies from its
beginnings as a country and recent
international trade arrangements
Copyright 2012 by McGraw-Hill Ryerson
Limited. All rights reserved.

The Importance of Trade

(a)
Canada has shown a heavy reliance on trade,

with exports representing 35% of its GDP.

When compared with other countries, Canadas

exports are a higher proportion of GDP than is

average for the worlds countries, including
Japan and the US.
Some small industrialized countries, such as
Belgium, have a higher reliance on foreign
trade than does Canada.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Importance of Trade

(b)
Figure 15.1, Page 404

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Canadas Trade Patterns

(a)

Canadas primary trading partner is the US,

which buys almost three-quarters of Canadian
merchandise exports and provides just under
two-thirds of Canadian merchandise imports.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Canadas Merchandise Trade by Region

(2010)
Figure 15.2, Page 405

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Canadas Trade Patterns

(b)
Canadas merchandise exports are about
equally divided between natural resources
(both raw and processed) and manufactured
goods.
Canadas merchandise imports of
manufactured goods are more than double its
merchandise imports of natural resources
(both raw and processed).

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Canadas Merchandise Trade by Type of

Product (2010)
Figure 15.3, Page 406

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Canadas Trade Patterns

(c)

The impact of Canadas service sector on

trade is not fully reflected in the stated figures
for service exports and imports.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

What is Traded

Three main factors determine what products a

country exports and imports:
resources
market size
climate

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Case for Trade

International trade brings three main

economic gains:
product variety
competition
specialization

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Absolute and Comparative

Advantage

Specialization can be based on either absolute

advantage or comparative advantage.
Absolute advantage is exhibited by a producer

who can supply a certain quantity of an item

more efficiently than can other producers.
Comparative advantage is exhibited by a
producer who can supply a certain item with a
lower opportunity cost than can other
producers.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Gains from Trade Based on Absolute

Advantage
Figure 15.4, Page 408

Lawyer
Carpenter

Time Spent
Building
Furniture

Time Spent
Preparing
a Will

Time Saved
through
Specialization

20 hours
5 hours

2 hours
10 hours

20 2 = 18 hours
10 5 = 5 hours

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Gains from Trade Based on Comparative

Advantage
Figure 15.5, Page 409
Hypothetical Output
Per Worker

Canada
paper
Mexico
paper

Opportunity
Cost

Paper

Computers

of 1 tonne
of paper

12 tonnes

12 computers

1.0 computer

1.0 tonnes

3 tonnes

9 computers

3.0 computers

0.33 tonnes

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

of 1
computer

Total Gains from

Specialization
Figure 15.6, Page 410

Before Trade

Canada
Mexico

After Trade

Paper

Computers

Paper

60 tonnes
30 tonnes

60 computers
90 computers

120 tonnes
0 tonnes

0 computers
180 computers

90 tonnes

150 computers

120 tonnes

180 computers

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Computers

The Terms of Trade

The terms of trade represent the international
price of one product in terms of another.
The limits of the terms of trade for a pair of
products traded between two countries are
determined by the cost ratios of the products
in each country.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Impact of Trade

Protection (a)

In a perfectly competitive market:

a tariff (which is an excise tax on imported

goods) decreases consumption and foreign

imports, while it increases domestic production
and government revenues
an import quota (which is a non-tariff barrier)
has the same effect as a tariff, except that the
increase in government revenues is replaced by
an increase in the price of foreign imports

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Case for Trade

Protection

Seven arguments are used to support trade

protection:
domestic employment
infant industries
terms of trade
environment and safety standards
cheap foreign labour
national security
cultural sovereignty
Copyright 2012 by McGraw-Hill Ryerson
Limited. All rights reserved.

Past Canadian Trade Policies

(b)
The General Agreement on Tariffs and Trade

(GATT) and its replacement, the World Trade

Organization (WTO), represent multilateral
initiatives to reduce trade protection among
member countries, including Canada.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Average Tariff Rates in

Canada
Figure 15.8, Page 419

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Recent Trade Blocs (a)

A trading bloc (which is a relatively small

number of countries involved in a trade
agreement) can take three forms:
A free trade area is an area in which
trade is tariff-free, although member
countries are able to impose separate
trade barriers on outside countries (e.g.
NAFTA).

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Recent Trade Blocs (b)

A customs union is a group of countries

with common trade barriers with outside

countries as well as a free trade area
(e.g. Mercosur).
A common market is a customs union
that allows for the free movement of
labour and capital among member
countries (e.g. the EU).

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Free Trade

Agreement (a)

The Free Trade Agreement (FTA) signed by

Canada and the US in 1988:
has eliminated tariffs on virtually all

products
includes services
reduces governments ability to screen
foreign direct investment

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The Free Trade

Agreement (b)

has introduced a new North American

content rule for autos

has created a continental energy market
excludes cultural industries
has been accompanied by a significant
increase in trade between the two
countries

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

The North American Free Trade

Agreement

The North American Free Trade Agreement

(NAFTA) signed by Canada as well as the US
and Mexico in 1993:
extends most of the provisions of the FTA to

include Mexico
includes side agreements concerning labour
and environmental standards
has so far had little effect on Canada given
Canadas relatively minor trade with Mexico

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Globalization (OLC) (a)

According to Canadian economist John

Helliwell, national borders still have an

extensive effect on trade patterns and flows of
financial capital.
These border effects are also significant for
movements of people. Despite perceptions to
the contrary, the proportion of Canadians
moving to the US is much lower than in
previous decades.
Copyright 2012 by McGraw-Hill Ryerson
Limited. All rights reserved.

Globalization (OLC) (b)

Helliwell suggests that Canadian economic

welfare compares well with other nations,

and in particular the US, which illustrates
how small economies can stand up against
larger economies in todays global
economy.
Satisfaction with our health care system
is relatively high by international
standards.
Copyright 2012 by McGraw-Hill Ryerson
Limited. All rights reserved.

Globalization (OLC) (c)

Canada has been relatively successful at

educating its workforce, though there are

some problems in the area of knowledge
production (ie. research).
Canada has high levels of social capital,
which refers to levels of mutual trust
found in society.

Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.

Understanding
Economics
6th edition
by Mark Lovewell

Chapter 15
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.