Professor H.J. Schuetze Economics 370

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1 Topic 3.1c - Trade Professor H.J. Schuetze Economics 370 Opening Up to Trade Unlike what the simple labour demand model assumes, labour markets do not operate in a global vacuum To be certain, the Canadian and other labour markets are operating in an increasingly globally competitive market Trade policies such as NAFTA and GATT likely mean that competition from others countries will continue to increase The merit of such policies is a hotly debated topic The main concern is that the relatively high wage countries like Canada may have to reduce wages, employment or both to compete. Professor Schuetze - Econ

2 1. Single Labour Market (Canada) Short-Run: Competition from low wage countries that produce goods cheaper lowers the price that Canadian firms can sell their goods for wage w c * MRP N =P MP N N * c N The reduction in price lowers the MRP N in Canada If the Canadian equilibrium wage remains constant equilibrium employment falls Professor Schuetze - Econ Offsetting Factors 1. The wage rate in Canada could fall far enough to maintain employment 2. The marginal productivity of labour could increase Professor Schuetze - Econ

3 1. Single Labour Market (Canada) Long-Run: Suppose instead that Canadian labour is one input in global production L F L F * MP NC / MP NF = w C /w F Q 0 L * C Slope=-w C /w F L C Professor Schuetze - Econ Long-Run Might expect firms to substitute towards foreign labour (jobs move to low-wage countries) This will only be true if labour in Mexico is a perfect substitute for Canadian Labour The tangency condition implies: Professor Schuetze - Econ

4 Professor Schuetze - Econ Labour Costs Table 5.1 gives hourly compensation costs including fringe benefits Costs are converted to Canadian dollars using exchange rates Thus, the values reflect variation in exchange rates How does Canada stack up? Canada appears to be reasonably competitive lying somewhere in the middle of the pack Professor Schuetze - Econ

5 Labour Costs and Productivity How do Germany and Scandinavia compete? Thus, a better indicator of a countries ability to compete is unit labour cost As an example, consider Canada s position relative to the United States Professor Schuetze - Econ Labour Costs and Productivity Output per hour = est. value of output per hour of labour input (AP N ) Values are indices of Canadian to U.S. costs base Professor Schuetze - Econ

6 2. Cross-Sector Impact of Trade The models we have looked at so far are overly simplistic to capture the primary benefits of trade The idea is that through specialization gains from trade can be had if there are comparative advantages in production across countries Comparative advantage and trade: Suppose a small economy, like Canada produces only two goods: beer and wine Define: Production Possibilities Frontier (PPF) Professor Schuetze - Econ Production Possibilities Frontier Beer 100 If produce no wine could produce 100 cases of beer If allocate all resources to wine, could produce 15 cases 15 Wine Slope of the PPF represents opportunity cost eg e.g. Bowed outward because inputs tend to be specialized e.g. Have to give up more and more beer production (steeper slope) Professor Schuetze - Econ

7 Optimal Production/Consumption Suppose there is a representative consumer with preferences over beer and wine consumption Simply maximize utility subject to the PPF Beer A A U A Wine Optimal production/consumption occurs at a point of tangency Suppose the slope of the PPF at the point of tangency equals -5 Thus, the slope of the indifference curve is also -5 (A - A ) Professor Schuetze - Econ Gains From Trade Suppose we open up our economy to the world market through an agent Importing from the agent necessarily entails exporting to the agent If the agent offers to exchange 1 case of wine for 5 cases of beer our economy is no better off (at the margin) so we won t exchange Professor Schuetze - Econ

8 I. No Change in Production Beer A B B Even if we don t change production, with the ability to trade our consumption opportunities would increase A U A Wine The slope of B -B B is equal to -3 Professor Schuetze - Econ II. Change Production If our economy specializes in the production of beer (produce less wine) we could increase utility even further Beer A Specialize and shift production to C Because we get a relatively higher price for beer the economy could reach an even higher indifference curve A U A Wine This result depends only on having a comparative advantage in the production of one of the goods Professor Schuetze - Econ

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