Nafta and the Effects That It Has Had on the Canadian Economy

Topics: International trade, Economics, United States Pages: 6 (2540 words) Published: October 15, 2012
In the country that I have been researching, there have been many economic ruts. Canada has gone through tons of hardships such as droughts, depression, and most recently the current housing bubble crisis. With all said and done, there has been no greater impact on the Canadian economy and way of life like the implementation of the North American Free Trade Agreement (NAFTA). Throughout my paper, I will be explaining and giving insight on the effects that NAFTA has had on the Canadian economy; Both the good and the bad. I will be describing the background of how NAFTA came to be, as well as presenting examples of the different ideas behind the whole “international free trade” A helpful way to understand the whole concept of International free trade is that it is primarily based on the idea of comparative advantage. A country has the comparative advantage of the production of a good when the opportunity cost of producing that good is lower relative to the other country. According to the Ricardian Model in an economy with two goods each country will produce both of those goods at some point along their production possibilities frontier in autarky. (Engardio) The labor in each country is divided into the production of each good and the marginal product of labor is determined by the level of technology. Levels of technology differ across countries thus no-trade prices differ as well. These differences in prices create an incentive for countries to trade. For example, let’s say Canada and the United States both only produced two goods; chairs and cars. The cost of producing one chair in the United States is one car. The cost of producing one chair in Canada is ½ a car. This means that Canada has the comparative advantage in the production of chairs. Conversely the cost of producing one car in Canada is two chairs as opposed to one chair in the United States. The U.S. has comparative advantage in the production of cars. When these two countries open to trade Canada will specialize in the production of chairs and the U.S. will specialize in the production of cars and they will trade these two goods at the world price. The world price lies somewhere between the pre-trade opportunity costs or prices of each country. When opening up to trade the U.S. will export the surplus of cars that it does not consume to Canada and Canada will export the surplus of chairs it does not consume to the U.S. At the world price the U.S. can sell cars at a higher price and buy chairs at a lower price than it could under autarky. The same happens in Canada. The specific factors model follows the same concept of overall gains from trade but adds two more factors of production; land and capital. With these factors of production the ideas of diminishing returns to scale and the marginal product of labor are introduced. With each additional worker the overall production increases but at a diminishing rate. The wage of each worker is equal to his or her marginal product of labor multiplied by the price of that good. The real wage of the worker is determined by what he or she can purchase with that wage in terms of either chairs or cars. The factors of production in these two goods are lumber and manufacturing. As the price of one of these factors increases wages increase and thus workers shift from producing one good and work in the production of the good with the highest price. In the article Ernie Smith lost his job in the furniture industry because of the competition imposed by Canada after opening up to trade. Shortly after losing his job, however, he found a different job in the custodian industry. This transfer of jobs can be related to the difference in wages. Prices decreased in the furniture industry because of the competing Canadian companies. This decrease in prices essentially decreased Ernie’s wage to the point where he was no longer needed at the company. He then found a new job where the wage was higher in a different industry. (Engardio)...
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