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Econ 219 Notes After Midterm .docx

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McGill University
Economics (Arts)
ECON 227
Christopher Ragan

Section 4: Canada’s Demographic Challenges The Causes of Population Aging - Population = Births + Net Immigration – Deaths - These factors also tell us how the average age of the population will change - The decrease in birth rate reduces the population growth rate and increases the average age of the population  Declining Fertility Since 1950s - Due to large increase in the participation of women in the Canadian labor force - Significant culture and religious changes in Canadian society also contributed to the decline - Canada’s population growth rate is predicted to decline gradually over the next few decades, mostly driven by further modest declines in the fertility rate  Increasing Life Expectancy - Due partly to an increase in healthier lifestyles on the part of the average Canadian – including a reduction in smoking and alcohol consumption, modification of eating habits, and increases in regular exercise - Also due to improvements in medical and pharmaceutical technology  The Inevitable Aging Population - Average age of the Canadian population has been rising - Falling birth rate implies that fewer young people are entering the population - Rising life expectancy implies that people are growing older before they die The Economic Challenges of Population Aging - Per Capita output in any year is made up of three component parts: o GDP/POP = (GDP/E) x (E/LF) x (LE/POP) o Where E is the number of people employed and LF is the number of the people in the labor force (sum of those employed and not working but actively seeking job) o (GDP/E) – Labor Productivity o (E/LF) – Employment to the size of the labor force o (LF/POP) – Labor-force participation rate  Declining Labor Force - When people get older, they eventually choose to leave the labor force and take their retirement - With an increase in aging population, the economy’s overall labor-force population rate will fall  Slowing Average Living Standards - Labor productivity, (GDP/E), has been increasing - Labor force actually employed, (E/LF), fluctuates considerably over the business cycle but stable over long periods of time - The declining fraction of the population at work will tend to offset the effects of ongoing productivity growth on the growth of per capita incomes  Importance of Productivity Growth - Productivity growth is the single largest factor driving average incomes over long periods of time - Changes in output driven by: o The quality and quantity of labor o The quality and quantity of physical capital o The level of technological - While improvements in the quality of labor will generally add to productivity and thus to average per capita incomes, increases in the quantity of labor (with constant quality) will increase total output but because of the diminishing marginal product of labor, will generally lead to reductions in per capita income - Increase in quantity of physical capital often leads to an increase in its quality so governments typically focus on policies designed to increase firms’ incentives to invest in new capital by: o Reducing corporate tax rates o Reduce specific sales taxes on tariffs that apply to business inputs – reducing the cost for firms that choose to invest in new capital - Governments would also focus on policies designed to increase the level of technological knowledge by: o Governments can directly support research in universities and private-sector laboratories o Tax-related policies designed to reduce firms’ direct costs of conduction expensive research and development - Policies aimed at enhancing the degree of competition between firms may have the effect of spurring technological development as firms realize that only with new innovations and inventions can they hope to succeed against their corporate rivals The Fiscal Challenges of Population Aging - Two parts: o The aging of the population will lead to a decline of the growth rate of the governments’ tax base o Key Canadian government spending programs will become more costly as the population ages A Slowing Tax Base - Canadian governments levy all kinds of taxes: o Income tax: Apply to personal income and corporate profits o GST and Provincial taxes: Apply to the level of consumption expenditure - Government tax revenues tend to rise quickly when national income rises quickly; they tend to slow down (or fall) when national income slows down (or falls) Rising Age Related Spending - The average amount of resources spent on health care per person rises significantly as the person ages - Government spending on healthcare will also increase as population aging increases - Two other factors lead to spending: o As real per capita incomes continue to increase, it is estimated that the demand for health care will also rise and more than in proportion to the increase in income o Continuing development of new and expensive medical technologies - The aging of the Canadian population will also lead to increased demand for public spending on old-age benefits Fiscal Tensions Between Levels of Government - The aging of the Canadian population, and thus the increased demands for health- care spending, will create significant fiscal tensions between the federal and provincial governments for the simple reason that the majority share of the increased spending will come form the provincial budgets - At the same time however, nothing will generate an automatic transfer of taxing power toward the provinces - Thus, a population aging drives the increase in age-related spending, there will likely be an increased demand for financial transfers from federal government to provinces - Political tensions will be creates The Need to Make Difficult Fiscal Choices - Ways to increase financial transfers: o Reduce provincial spending on items other than health care, but this is unpopular because it implies reduced levels of services being provided to provincial residents o To increase provincial taxes to pay for the increases in the heal-care budget, but few voters ever embrace the idea of higher taxes - Greater financial transfers to the provinces would certainly make life easier for provincial government, but the burden would then be squarely on the federal government to make the tough decisions - The government would only be able to make larger transfers to the provinces if it could either restrain other types of spending or increase taxes - Aging population is predicted to increase in Canada and thus an increase in demands for health-care spending and for income-support programs - Governments will need to respond to these new demands o First, if the governments can sufficiently reduce the growth rate of non-age- related spending, they can make room in their budgets for the coming increases in age-related spending without the need for higher taxes  This is possibly but politically controversial o Second, if governments can sufficiently restrain the growth of health-care spending itself, they may be able to accommodate the effects of population aging without resorting to higher taxes or cuts to other spending programs  Governments must find a way to restrain growth in health-care spending that comes from technology and income  Debate on whether this is possible and how it can be achieved o Third, governments can choose to accommodate the rising demands for health-care spending by raising taxes  Canadians can be asked to pay for the greater services  Concerns with which taxes would be raised and by how much  This choice would affect Canadian income and future growth rate of average real income  None of these three options will be pleasant for the Canadian governments but some combinations of these choices will be inevitable  If the government were to go with borrowing money, they will form a liability with interest which will need to be paid Chapter 33: Globalization and International Trade 33.1 The Gains from Trade Interpersonal, Interregional and International Trade - Without trade, people must be self-sufficient - With trade, people can specialize efficiently and satisfy other needs by trading - This basic principle is true for individuals, regions and countries: o The gains from trade Illustrating the gains from trade - Absolute Advantage: When a country can produce some commodity at a lower absolute cost than another country. - Comparative Advantage: When a country can produce a good or service at a lower opportunity cost than another country. o Even though a country may have an absolute advantage in all goods, it cannot have a comparative advantage in all goods. o The gains from specialization and trade depend on the pattern of comparative, not absolute, advantage. o World output increases if countries specialize in the production of goods in which they have a comparative advantage – specialization of production against the pattern of comparative advantage leads to a decline in the total world output. Conclusions: - If a country has a comparative advantage in one product, it must have a comparative disadvantage in another. - When opportunity costs are the same in all countries, there are no gains from specialization and trade - When opportunity costs differ across both countries, global production can be increased by reallocating resources The Gains from Trade with Variable Costs - Additional gains from trade may be possible: o Economies of Scale (larger production, lower cost)  International trade allows small countries to produce high enough levels of output to reap the available sale economies o Learning by Doing  Reduction in unit costs that often results as workers learn through repeatedly performing the same tasks. It causes a downward shift in the average cost curve. Sources of Comparative Advantage - Factor Endowments o Countries have the comparative advantage in products that use their abundant resources relatively intensively - Climate o Variation in national climates affects comparative advantages o Climate can be considered a “special” factors of production - Human Capital o People can acquire skills that influence a country’s comparative advantage - Dynamic o Comparative advantage can be acquired or lost over time. o It is a dynamic concept 33.2 The Determination of Trade Patterns The Law of One Price - When an easily transported product is internationally traded, arbitrage will guarantee a single world price o Arbitrage – by low and sell high o Eg. Diamonds will not have a large price differential because they’re small and highly valued. - Compare the world price with the Canadian autarkic price: o If p w p dCanada exports it o If p w p dCanada imports it Is Comparative Advantage Obsolete? - The theory that comparative advantage determines trade flows is not obsolete - But the idea that CA is completely determines by forces beyond the reach of public policy has been discredited - Although governments may influence patters of CA, it is not necessarily advisable: o Compare the costs of trade-related policies with their likely benefits The Pattern of Foreign Trade: - An Exported Product o Countries export products whose world price exceeds the price that would exist domestically if there were no foreign trade. o Countries export the goods for which they are low-cost producers. That is, they export goods for which they have a comparative advantage. - An Imported Product o Countries import products whose world price is less than the price that would exist domestically if there were no foreign trade. o Countries import the goods for which they are high-cost producers. That is, they import goods for which they have a comparative disadvantage. The Terms of Trade - The ratio of the average price of a country’s exports to the average price of its imports. - Relative prices in which countries trade - The division of the gains from trade depends on the terms of trade - The terms of trade are measured by the ratio of the price of exports to the price of imports o Terms of Trade = - A rise in the price of imported goods, with the price of exports unchanged, indicated a fall in the terms of trade; it will now take more exports to buy the same quantity of imports. - A rise in the price of exported goods, with the price of imports unchanged, indicated a rise in the terms of trade; it will now take fewer exports to buy the same quantity of imports. - The ratio of these prices measures the amount of imports that can be obtained per unit of goods exported. - A rise in a country’s terms of trade is beneficial because it expands the country’s consumption possibilities. “Free trade generates benefits for all but costs for some.” Explain. 34.1 Free Trade or Protection? Trade policy: A government’s policy involving restrictions placed on international trade. Protectionism: Any policies designed to protect domestic industries from foreign competition Tariffs: A tax applied on imports of goods or services. Non-Tariff barriers: Restrictions other than tariffs designed to reduce imports. The Case for Free Trade - Free trade encourages countries to specialize along the lines of comparative advantage o Allows an increase in average material living standards - But free trade does not necessarily make every individual better off - The gains from specialization and trade make a country better off as a whole The Case for Protection - Two important valid arguments for protection: o Objectives other than maximizing national income:  Diversification  Advantages from a diversified pattern of production  Decreases fluctuations in the economy from producing more than what the country specializes in o Diverting some resources from their specialized product to other different products  Makes the economy less dependent on the volatility of the economy  Social  The protection of specific groups (machinery workers, dairy farmers, etc. depending on specialized product)  Trade restrictions can improve the earnings of one group whenever the restrictions increase the demand for that group’s services. This is done at the expense of a reduction in overall national income and hence the countries average living standards.  Social and distributional concerns may lead to the rational adoption of protectionist policies. But the cost of such protection is a reduction in the country’s average living standards.  In both cases, the cost is reduced average income o Maximize national income, possibly at the expense of other countries’ incomes:  Improve the terms of trade  Only possible for large countries  If the country imports a large world share of a particular good, by putting on a tariff, the country can drive down the world price of that imported good and thereby improve the terms of trade  This does not apply unless the country is big enough to influence the world price  Protect ‘infant’ industries  The argument that new domestic industries with potential for economies of scale or learning by doing need to be protected from competition from established, low-cost foreign producers so that they can grow large enough to achieve costs as low as those of foreign producers.  One practical problem with this argument for protection is that some infants “never grow up”.  Earn pure profits in foreign markets  Strategic trade policy  Subsidizing products sent to foreign countries in order to take over the market and so the profits goes back to the country; however, when this is done, the foreign country will reciprocate by doing the same and if both countries are subsidizing roughly equally, it does not change the market share and does not help the people at all and the country is just shoveling the tax payers’ funds into the firms without getting anything back - Four fallacious arguments for protection (check book for diagrams) o Protectionist policies help “keep the money at home”  Protecting a domestic industry so that the local people buy the local products rather than the foreign made products thus “keeping the money at home”  Problem: this suggests that when you buy foreign products, the money disappears to the foreign country; however, this money enables that foreign country to buy your local products or services  Not really keeping the money at home because the money will come back anyway o Protection from low-wage foreign labor  Putting tariffs on the imports of cheap goods coming from a low-wage foreign country in order to protect domestic producers from the low- wage competition  There is nothing on the gains from trade that says that a country does not gain from trade with a low-wage or high-wage country  A country’s low-wages in driven by their low productiveness  By protecting yourself from low-wage labor, you remove your access to low prices goods – forcing domestic people to buy more expensive products o Exports are “good” whereas imports are “bad”  With exports, the country receives money and gives goods while with imports, the country gives money and receives goods – people would rather receive money than give money this exports > imports  In order to get imports, the country must export o Protectionist policies create more domestic jobs  Putting tariffs on a certain product to protect jobs to create that particular product but it does not protect total jobs  A tariff on a cert
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