The Market System &
International Trade
SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
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In this chapter you will learn
4.1 The basic institutions required for a
market economy
4.2 The Four Fundamental Questions any
economy faces
4.3 About market failure and how
government can rectify it
4.4 About the gains from international trade
©2005 McGraw-Hill Ryerson Ltd.
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Chapter 4 Topics
4.1 Characteristics of the Market System
4.2 The Market System at Work
4.3 Market Failure
4.4 Canada & International Trade
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
– individuals & firms own resources
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
– individuals & firms own resources
– also intellectual property
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
– individuals & firms own resources
– also intellectual property
– facilitates exchange
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
• freedom of enterprise & choice
– freedom of enterprise: businesses can buy &
sell as they choose
– freedom of choice:
– owners can use or sell property as they choose
– workers can work where they like
– consumers can buy what they want
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
• freedom of enterprise & choice
• self-interest
– businesses seek profits
– consumers seek value
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
• freedom of enterprise & choice
• self-interest
• competition
– independently acting sellers & buyers
– easy entry & exit
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
• freedom of enterprise & choice
• self-interest
• competition
• markets & prices
– prices signal scarcity & guide resource
allocation
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Required characteristics for market system:
• private property
• freedom of enterprise & choice
• self-interest
• competition
• markets & prices
• active, but limited government
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Characteristics of the Market System
Other Characteristics
• technology & capital goods
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Characteristics of the Market System
Other Characteristics
• technology & capital goods
• specialization
– division of labour
– ability differences
– learning by doing
– saving time switching tasks
©2005 McGraw-Hill Ryerson Ltd.
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Characteristics of the Market System
Other Characteristics
• technology & capital goods
• specialization
– division of labour
– ability differences
– learning by doing
– saving time switching tasks
– geographic specialization
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Characteristics of the Market System
Other Characteristics
• technology & capital goods
• specialization
• use of money
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Chapter 4 Topics
4.1 Characteristics of the Market System
4.2 The Market System at Work
4.3 Market Failure
4.4 Canada & International Trade
©2005 McGraw-Hill Ryerson Ltd.
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Four Fundamental Questions
1. What will be produced?
•
•
•
those goods & services that can be
produced at a profit
what consumers vote for with their dollars
market restraints on freedom
consumer sovereignty
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Four Fundamental Questions
1. What will be produced?
2. How will the goods & services be
produced?
•
with the most efficient, least-costly methods
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Four Fundamental Questions
1. What will be produced?
2. How will the goods & services be
produced?
3. Who will get the goods & services?
•
those with the greatest willingness & ability
to pay
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
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Four Fundamental Questions
1. What will be produced?
2. How will the goods & services be
produced?
3. Who will get the goods & services?
4. How will the system
accommodate
– guiding
function of prices
change?
– role in promoting progress
•
by responding to price
& profit signals
– technological
advance
– creative destruction
– capital accumulation
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
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Competition & the “Invisible Hand”
• prices communicate information about
scarcity & value
• competition forces producers & resource
suppliers to respond
• firms, acting in their own best interest, also
promote society’s interests in terms of
efficiency
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Competition & the “Invisible Hand”
Three special merits of the market system:
• Efficiency
• Incentives
• Freedom
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Chapter 4 Topics
4.1 Characteristics of the Market System
4.2 The Market System at Work
4.3 Market Failure
4.4 Canada & International Trade
©2005 McGraw-Hill Ryerson Ltd.
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Market Failure
Spillovers or Externalities
• spillover costs
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Market Failure
Spillovers or Externalities
• spillover costs
– correction through
– legislation
– specific taxes
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Market Failure
Spillovers or Externalities
• spillover benefits
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Market Failure
Spillovers or Externalities
• spillover benefits
– correction through
– subsidization of consumers/suppliers
– provision via government
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Market Failure
Public Goods and Services
• non-rivalry
• non-excludability
• free-rider problem
Quasi-Public Goods
• healthcare, education, streets, police, fire, etc.
• could be priced/provided by private firms
• because of positive spillovers, government
intervenes
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Market Failure
The Reallocation Process
• reallocation of resources through the tax system
• resources released from private consumption
and investment to public and quasi-public goods
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Market Failure
Limitations of the Market System
• market system has remarkable virtues
• also well-known limitations
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The Circular Flow Revisited
(1) $ INCOME -RENTS
(1)COSTS
BUSINESSES
(9)GOODS &
SERVICES
GOVERNMENT
NET TAXES
(11)
(4) GOODS &
SERVICES
(5)
$
HOUSEHOLDS
NET TAXES
(12)
(6)
GOODS &
SERVICES
(4) GOODS &
SERVICES
PRODUCT
MARKETS
(3) REVENUE
©2005 McGraw-Hill Ryerson Ltd.
LABOUR
INTEREST
(10)GOODS &
SERVICES
(7)
$
(2) LAND
(8)
FACTORS OF
PRODUCTION
CAPITAL
(2)FACTORS OF
PRODUCTION
RESOURCE
MARKETS
(3) CONSUMPTION SPENDING
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Chapter 4 Topics
4.1 Characteristics of the Market System
4.2 The Market System at Work
4.3 Market Failure
4.4 Canada & International Trade
©2005 McGraw-Hill Ryerson Ltd.
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Global Competition
• globalization one of the major trends of our
time
• it has brought intense competition
• international trade & the global economy
affect Canadians daily
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Chapter 4
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International Linkages
•
•
•
•
goods & services flows
capital & labour flows
information & technology flows
financial flows
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Specialization & Comparative
Advantage
• specialization & international trade
increase the productivity of a nation’s
resources & allow for greater output than
would otherwise be possible
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Basic Principle
• even if one trading partner has absolute
advantage, all partners can benefit from
specialization according to comparative
advantage
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Comparative Costs
• suppose Canada & Mexico produce corn
& soybeans
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Chapter 4
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Comparative Costs
MEXICO
TABLE 4-1
PRODUCTION ALTERNATIVES
Product
A
Corn
20
24has 40
60
Canada
comparative
15
10
9
5
0
advantage in
soybeans
PRODUCTION
ALTERNATIVES
Soybeans
CANADA
TABLE 4-2
B
C
D
Soybeans:
E
0
Product
R
S
T
U
V
Corn
0
30
33
60
90
Soybeans
30
20
19
10
0
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
Mexico must give
up 4 tonnes of
corn for 1 tonne
of soybeans
Canada must
give up 3 tonnes
of corn for 1
tonne of
soybeans
38
Comparative Costs
MEXICO
TABLE 4-1
PRODUCTION ALTERNATIVES
Product
A
Corn
Mexico
has
20
24
40
60
15 comparative
10
9
5
0
advantage in
corn ALTERNATIVES
PRODUCTION
Soybeans
CANADA
TABLE 4-2
B
C
D
Corn:
E
0
Product
R
S
T
U
V
Corn
0
30
33
60
90
Soybeans
30
20
19
10
0
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
Mexico must give
up ¼ tonne of
soybeans for 1
tonne of corn
Canada must
give up 1/3
tonne of
soybeans for 1
tonne of corn
39
Terms of Trade
• must be between the domestic opportunity
costs for each country
• many possibilities can be mutually
beneficial
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Chapter 4
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Gains from Specialization & Trade
Table 4-4
Canada
Mexico
corn
soybeans
corn
soybeans
Outputs before
specialization
33
19
24
9
Outputs after
specialization
0
30
60
0
+35
-10
-35
+10
35
20
25
10
2
1
1
1
Amounts traded
Outputs available
after trade
Gains from
specialization &
trade
©2005 McGraw-Hill Ryerson Ltd.
Chapter 4
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Back to the Circular Flow Model
Figure 4-3
CANADIAN
RESOURCE
MARKETS
INPUT FACTORS
FACTORS OF
PRODUCTION
FACTORS OF
PRODUCTION
EXPENDITURES
GOODS
GOODS
CANADIAN
GOVERNMENT
CANADIAN
BUSINESSES
NET
TAXES
EXPENDITURES
GOODS & SERVICES
Foreign Expenditures
Cdn. Exports
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CANADIAN
HOUSEHOLDS
NET
TAXES
GOODS & SERVICES
CANADIAN
PRODUCT
MARKETS
REST
OF THE
WORLD
Chapter 4
GOODS & SERVICES
Cdn. Imports
Cdn. Expenditures
42
Chapter 4 Topics
4.1 Characteristics of the Market System
4.2 The Market System at Work
4.3 Market Failure
4.4 Canada & International Trade
©2005 McGraw-Hill Ryerson Ltd.
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