©2005 McGraw-Hill Ryerson Ltd. Chapter 4 1 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE The Market System & International Trade

©2005 McGraw-Hill Ryerson Ltd.©2005 McGraw-Hill Ryerson Ltd. Chapter 4Chapter 4 11

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGESLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

The Market System & The Market System & International TradeInternational Trade


In this chapter you will learnIn this chapter you will learn

4.14.1 The basic institutions required for a The basic institutions required for a market economymarket economy

4.24.2 The Four Fundamental Questions any The Four Fundamental Questions any economy faceseconomy faces

4.34.3 About market failure and how About market failure and how government can rectify itgovernment can rectify it

4.44.4 About the gains from international trade About the gains from international trade


Chapter 4 TopicsChapter 4 Topics

4.1 4.1 Characteristics of the Market SystemCharacteristics of the Market System

4.24.2 The Market System at Work The Market System at Work

4.34.3 Market Failure Market Failure

4.44.4 Canada & International Trade Canada & International Trade


Characteristics of the Market SystemCharacteristics of the Market System

Required characteristics for market system:Required characteristics for market system:• private propertyprivate property

– individuals & firms own resourcesindividuals & firms own resources



– individuals & firms own resourcesindividuals & firms own resources– also intellectual propertyalso intellectual property




– individuals & firms own resourcesindividuals & firms own resources– also intellectual propertyalso intellectual property– facilitates exchangefacilitates exchange



Required characteristics for market system:Required characteristics for market system:• private propertyprivate property• freedom of enterprise & choicefreedom of enterprise & choice

– freedom of enterprisefreedom of enterprise: businesses can buy & : businesses can buy & sell as they choosesell as they choose

– freedom of choicefreedom of choice: : – owners can use or sell property as they chooseowners can use or sell property as they choose– workers can work where they likeworkers can work where they like– consumers can buy what they wantconsumers can buy what they want



Required characteristics for market system:Required characteristics for market system:• private propertyprivate property• freedom of enterprise & choicefreedom of enterprise & choice• self-interestself-interest

– businesses seek profitsbusinesses seek profits– consumers seek valueconsumers seek value



Required characteristics for market system:Required characteristics for market system:• private propertyprivate property• freedom of enterprise & choicefreedom of enterprise & choice• self-interestself-interest• competitioncompetition

– independently acting sellers & buyersindependently acting sellers & buyers– easy entry & exiteasy entry & exit



Required characteristics for market system:Required characteristics for market system:• private propertyprivate property• freedom of enterprise & choicefreedom of enterprise & choice• self-interestself-interest• competitioncompetition• markets & pricesmarkets & prices

– prices signal scarcity & guide resource prices signal scarcity & guide resource allocationallocation



Required characteristics for market system:Required characteristics for market system:• private propertyprivate property• freedom of enterprise & choicefreedom of enterprise & choice• self-interestself-interest• competitioncompetition• markets & pricesmarkets & prices• active, but limited governmentactive, but limited government



Other CharacteristicsOther Characteristics

• technology & capital goodstechnology & capital goods





• specializationspecialization– division of labourdivision of labour– ability differencesability differences– learning by doinglearning by doing– saving time switching taskssaving time switching tasks





• specializationspecialization– division of labourdivision of labour– ability differencesability differences– learning by doinglearning by doing– saving time switching taskssaving time switching tasks

– geographic specializationgeographic specialization





• specializationspecialization

• use of moneyuse of money









Four Fundamental QuestionsFour Fundamental Questions

1.1. What will be produced?What will be produced?• those goods & services that can be those goods & services that can be

produced at a profitproduced at a profit• what consumers vote for with their dollarswhat consumers vote for with their dollars• market restraints on freedommarket restraints on freedom

consumer sovereigntyconsumer sovereigntyconsumer sovereigntyconsumer sovereignty



1.1. What will be produced?What will be produced?

2.2. How will the goods & services be How will the goods & services be produced?produced?

• with the most efficient, least-costly methodswith the most efficient, least-costly methods





3.3. Who will get the goods & services?Who will get the goods & services?• those with the greatest willingness & ability those with the greatest willingness & ability

to payto pay





3.3. Who will get the goods & services?Who will get the goods & services?

4.4. How will the system accommodate How will the system accommodate change?change?

• by responding to price & profit signalsby responding to price & profit signals

– guiding function of pricesguiding function of prices– role in promoting progressrole in promoting progress

– technological advancetechnological advance– creative destructioncreative destruction

– capital accumulationcapital accumulation

– guiding function of pricesguiding function of prices– role in promoting progressrole in promoting progress

– technological advancetechnological advance– creative destructioncreative destruction

– capital accumulationcapital accumulation


Competition & the “Invisible Hand”Competition & the “Invisible Hand”

• prices communicate information about prices communicate information about scarcity & valuescarcity & value

• competition forces producers & resource competition forces producers & resource suppliers to respondsuppliers to respond

• firms, acting in their own best interest, also firms, acting in their own best interest, also promote society’s interests in terms of promote society’s interests in terms of efficiencyefficiency


Three special merits of the market system:Three special merits of the market system:

• EfficiencyEfficiency

• IncentivesIncentives

• FreedomFreedom

Competition & the “Invisible Hand”Competition & the “Invisible Hand”








Market FailureMarket Failure

Spillovers or ExternalitiesSpillovers or Externalities• spillover costsspillover costs



Spillovers or ExternalitiesSpillovers or Externalities• spillover costsspillover costs

– correction throughcorrection through– legislationlegislation– specific taxesspecific taxes



Spillovers or ExternalitiesSpillovers or Externalities• spillover benefitsspillover benefits



Spillovers or ExternalitiesSpillovers or Externalities• spillover benefitsspillover benefits

– correction throughcorrection through

– subsidization of consumers/supplierssubsidization of consumers/suppliers– provision via governmentprovision via government



Public Goods and ServicesPublic Goods and Services• non-rivalrynon-rivalry• non-excludabilitynon-excludability• free-rider problemfree-rider problem

Quasi-Public GoodsQuasi-Public Goods• healthcare, education, streets, police, fire, etc.healthcare, education, streets, police, fire, etc.• could be priced/provided by private firmscould be priced/provided by private firms• because of positive spillovers, government because of positive spillovers, government

intervenesintervenes



The Reallocation ProcessThe Reallocation Process• reallocation of resources through the tax systemreallocation of resources through the tax system• resources released from private consumption resources released from private consumption

and investment to public and quasi-public goodsand investment to public and quasi-public goods



Limitations of the Market SystemLimitations of the Market System

• market system has remarkable virtuesmarket system has remarkable virtues

• also well-known limitationsalso well-known limitations


The Circular Flow RevisitedThe Circular Flow Revisited

BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS

RESOURCERESOURCEMARKETMARKETSS

PRODUCTPRODUCTMARKETMARKETSS

GOODS &GOODS &SERVICESSERVICES

GOODS &GOODS &SERVICESSERVICES

GOVERNMENTGOVERNMENT

(2)(2)FACTORS OFFACTORS OFPRODUCTIONPRODUCTION

(1)COSTS(1)COSTS

NET TAXESNET TAXES

(9)GOODS &(9)GOODS &SERVICESSERVICES

NET TAXESNET TAXES

$$ GOODS &GOODS &SERVICESSERVICES

REVENUEREVENUE CONSUMPTION SPENDINGCONSUMPTION SPENDING

LANDLAND LABOURLABOUR CA

PIT

AL

CA

PIT

AL

$ INCOME$ INCOME -RENTS-RENTS

INT

ER

ES

TIN

TE

RE

ST

$$(10)GOODS &(10)GOODS &

SERVICESSERVICES

FACTORS OF FACTORS OF PRODUCTIONPRODUCTION

(6)(6)

(1)(1)

(2)(2)

(7)(7)

(8)(8)

(12)(12)(11)(11)

(4)(4)

(3)(3) (3)(3)

(4)(4)

(5)(5)

WAGES

WAGES

PROFITS

PROFITS








Global CompetitionGlobal Competition

• globalization one of the major trends of our globalization one of the major trends of our timetime

• it has brought intense competitionit has brought intense competition

• international trade & the global economy international trade & the global economy affect Canadians dailyaffect Canadians daily


International LinkagesInternational Linkages

• goods & services flowsgoods & services flows

• capital & labour flowscapital & labour flows

• information & technology flowsinformation & technology flows

• financial flowsfinancial flows


Specialization & Comparative Specialization & Comparative AdvantageAdvantage

• specialization & international trade specialization & international trade increase the productivity of a nation’s increase the productivity of a nation’s resources & allow for greater output than resources & allow for greater output than would otherwise be possiblewould otherwise be possible


Basic PrincipleBasic Principle

• even if one trading partner has even if one trading partner has absolute absolute advantageadvantage, all partners can benefit from , all partners can benefit from specialization according to specialization according to comparative comparative advantageadvantage


Comparative CostsComparative Costs

• suppose Canada & Mexico produce corn suppose Canada & Mexico produce corn & soybeans& soybeans


MEXICOMEXICO

TABLE 4-1TABLE 4-1

PRODUCTION ALTERNATIVESPRODUCTION ALTERNATIVES

ProductProduct AA BB CC DD EE

CornCorn 00 2020 2424 4040 6060

SoybeansSoybeans 1515 1010 99 55 00

CANADACANADA

TABLE 4-2TABLE 4-2


ProductProduct RR SS TT UU VV

CornCorn 00 3030 3333 6060 9090


SoybeansSoybeans::

Mexico must give Mexico must give

up up 44 tonnes of tonnes of corn for 1 tonne corn for 1 tonne of soybeansof soybeans

Canada must Canada must

give up give up 33 tonnes tonnes of corn for 1 of corn for 1 tonne of tonne of soybeanssoybeans


Canada has Canada has comparative comparative advantage in advantage in

soybeanssoybeans

Canada has Canada has comparative comparative advantage in advantage in

soybeanssoybeans


MEXICOMEXICO

TABLE 4-1TABLE 4-1


ProductProduct AA BB CC DD EE

CornCorn 00 2020 2424 4040 6060


CANADACANADA

TABLE 4-2TABLE 4-2


ProductProduct RR SS TT UU VV

CornCorn 00 3030 3333 6060 9090


CornCorn::

Mexico must give Mexico must give up up ¼¼ tonne of tonne of soybeans for 1 soybeans for 1 tonne of corntonne of corn

Canada must Canada must

give up give up 1/31/3 tonne of tonne of soybeans for 1 soybeans for 1 tonne of corntonne of corn


Mexico has Mexico has comparative comparative advantage in advantage in

corncorn

Mexico has Mexico has comparative comparative advantage in advantage in

corncorn


Terms of TradeTerms of Trade

• must be between the domestic opportunity must be between the domestic opportunity costs for each countrycosts for each country

• many possibilities can be mutually many possibilities can be mutually beneficialbeneficial


CanadaCanada MexicoMexico

corncorn soybeanssoybeans corncorn soybeanssoybeans

Outputs before Outputs before specializationspecialization 3333 1919 2424 99

Outputs after Outputs after specializationspecialization

Amounts tradedAmounts traded

Outputs available Outputs available after tradeafter trade

Gains from Gains from specialization & specialization & tradetrade

00 3030 6060 00

+35+35 -10-10 -35-35 +10+10

3535 2020 2525 1010

22 11 11 11

Gains from Specialization & TradeGains from Specialization & TradeTable 4-4Table 4-4


CANADIANCANADIANBUSINESSESBUSINESSES

CANADIANCANADIANHOUSEHOLDSHOUSEHOLDS

CANADIANCANADIANRESOURCERESOURCEMARKETSMARKETS

CANADIANCANADIANPRODUCTPRODUCTMARKETSMARKETS

$ COSTS

$ COSTS

$ INCOMES

$ INCOMES

$ CONSUM

PTION

$ CONSUM

PTION$ REVENUE

$ REVENUE

GOODS & SERVICESGOODS & SERVICES

CANADIANCANADIANGOVERNMENTGOVERNMENT

RESTRESTOF THEOF THEWORLDWORLD

FACTORS OFFACTORS OFPRODUCTIONPRODUCTION

INPUT FACTORSINPUT FACTORS

EXPENDITURESEXPENDITURES

EXPENDITURESEXPENDITURES



GOODSGOODS GOODSGOODS

NETNETTAXESTAXES

NETNETTAXESTAXES

Cdn. ImportsCdn. Imports

Cdn. ExpendituresCdn. ExpendituresCdn. ExportsCdn. Exports

Foreign ExpendituresForeign Expenditures

Back to the Circular Flow ModelBack to the Circular Flow ModelFigure 4-3Figure 4-3

FACTORS OFFACTORS OFPRODUCTIONPRODUCTION







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©2005 McGraw-Hill Ryerson Ltd. Chapter 4 1 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE The Market System & International Trade