Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 5th edition by Mark Lovewell

Review Chapters 13, 14 and 15 5 th edition by Mark Lovewell

The Bank of Canada (a) The Bank of Canada performs four basic functions: It manages the money supply. It acts as the bankers’ bank: holding deposits of members of the Canadian Payments Association making advances to CPA members at the bank rate Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Bank of Canada (b) It acts as the federal government’s fiscal agent: holding some of the government’s bank deposits clearing the government’s cheques handling the financing of the government’s debt by issuing bonds (including Canada Savings Bonds and treasury bills) It helps supervise the operations of financial markets to ensure their stability. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Expansionary Monetary Policy (b) Figure 13.1, page 360 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. The Money Market Quantity of Money ($ billions) Nominal Interest Rate (%) The Economy Real GDP (2002 $ billions) Price Level (GDP deflator, 2002 = 100) a b c d e S m0 S m1 DmDm AD 0 AD 1 AS Potential Output Initial Recessionary Gap

Contractionary Monetary Policy (b) Figure 13.2, page 360 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. The Money Market Quantity of Money ($ billions) Nominal Interest Rate (%) DmDm S m1 S m0 a b AD 1 AS AD 0 c d e Potential Output The Economy Real GDP (2002 $ billions) Price Level (GDP deflator, 2002 = 100) Initial Inflationary Gap

Open Market Operations Open market operations are a tool the Bank of Canada uses to conduct monetary policy. A sale of bonds lowers a CPA member’s deposit liabilities and reserves, which causes a magnified decrease in the money supply using the money multiplier. A purchase of bonds raises a CPA member’s deposit liabilities and reserves, which causes a magnified increase in the money supply using the money multiplier. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in the Target Overnight Rate (a) Changing the target overnight rate is a tool the Bank of Canada uses to signify its monetary policy intentions. When the Bank of Canada changes its target band for the overnight rate it also automatically adjusts the bank rate since this rate is at the top end of the target band. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in the Target Overnight Rate (b) A rise in the target overnight rate signifies a contractionary policy in the near future while a fall in the target overnight rate signifies an expansionary policy. If the change in the target overnight rate is substantial, then deposit-takers also adjust their prime rate, which is the lowest possible rate charged on loans to deposit-takers’ best corporate customers. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Benefits and Drawbacks of Monetary Policy Monetary policy has two main benefits: It is separated from day-to-day politics. Decisions regarding monetary policy can be made quickly. Monetary policy has two main drawbacks: It is less effective as an expansionary tool than as a contractionary tool. It cannot be focused on particular regions. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Types of Inflation There are two main types of inflation: Demand-pull inflation occurs as rightward shifts in the AD curve pull up prices. Cost-push inflation occurs as leftward shifts in the AS curve push up prices. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand-Pull Inflation Figure 13.5, Page 365 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Price Level (GDP deflator, 2002 = 100) Real GDP (2002 $ billions) AD 0 AD 1 AS b a

Cost-Push Inflation Figure 13.8, Page 368 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Real GDP (2002 $ billions) Price Level (GDP deflator, 2002 = 100) AD AS 0 AS 1 c d

The Self-Stabilizing Economy (a) The economy has a self-stabilizing tendency due to long-run movements in the AS curve. If equilibrium real output is above potential output, then higher wages gradually push the AS curve leftward and decrease equilibrium output. If equilibrium real output is below potential output, then lower wages gradually push the AS curve rightward and increase equilibrium output. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Self-Stabilizing Economy (b) Figure 13.9, Page 369 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Real GDP (2002 $ billions) Price Level (GDP deflator, 2002 = 100) Potential Output AS c b a

The Balance of Payments Accounts The balance of payments accounts provide a summary of all transactions between Canadian residents and foreigners that involve exchanging Canadian dollars for some other currency. Receipts (shown by a + sign) represent monetary inflows to the Canadian economy. Payments (shown by a - sign) represent monetary outflows from the Canadian economy. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Current Account (a) The current account (which summarizes all foreign transactions associated with current economic activity in Canada and involving Canadian dollars) includes four types of transactions: trade in merchandise trade in services flows of investment income transfers Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Canada’s Current Account (2007) Figure 14.1, Page 380 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Merchandise trade =+48.0 Trade in services =-19.2 Balance of trade (net exports)+28.9 Investment Income =-14.2 Transfers =-1.1 Current account surplus=+13.6 (+) or deficit (-) Receipts (+) (Canadian $ inflows) (Canadian $ billions) Payments (-) (Canadian $ outflows) Balance (net) (Canadian $ inflows – Outflows)

Canada’s Capital and Financial Accounts (2007) Figure 14.2, Page 382 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Capital Account =+5.9 Financial Account Direct investment =+58.9 Portfolio investment-80.0 Other financial investment+3.8 Total capital and financial account surplus (+) or deficit (-) (excl. official reserves) Receipts (+) (Canadian $ inflows) (Canadian $ billions) Payments (-) (Canadian $ outflows) Balance (net) (Canadian $ inflows – outflows)

Canada’s Balance of Payments (2007) Figure 14.3, Page 384 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 1.Current account Capital and financial accounts Statistical discrepancy+4.1 Balance-of-payments surplus (+) or deficit (-) Changes in official reserves-4.6 (Canadian $ billions) Balance (net)

Changes in Official Reserves (a) The change in official reserves: shows the effect of the Bank of Canada’s buying and selling of foreign currency on the flow of Canadian dollars is equal in value (and opposite in sign) to the surplus or deficit noted in the balance of payments Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Exchange Rates and Prices The impact of exchange rates on prices can be illustrated using Canadian and U.S. dollars. A product’s U.S. dollar price = the Canadian dollar price x U.S. dollars to buy CDN$1.00. A product’s Canadian dollar price = the U.S. dollar price x Canadian dollars to buy US$1.00. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

A Foreign Exchange Market Figure 14.4, Page 387 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Canadian Dollar Demand and Supply Curves Quantity of Canadian Dollars (billions) Price of Canadian Dollar (in $US) D S a a c c b Shortage Surplus US$0.78 US$0.76 US$ – 40 = – 50 = 0 45 – 55 = -10 Canadian Dollar Demand and Supply Schedules Price of Cdn. Dollar (in $US) Quantity of Cdn. Dollars Supplied Quantity of Cdn. Dollars Supplied ($ billions) (surplus (+) or shortage (-)) -

Canadian Exchange Rates Figure 14.7, Page 396 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Importance of Trade (b) Figure 15.1, Page 406 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Canada’s Merchandise Trade by Region (2007) Figure 15.2, Page 407 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Canada’s Merchandise Trade by Type of Product (2007) Figure 15.3, Page 408 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

What is Traded Three main factors determine what products a country exports and imports: resources market size climate Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Case for Trade International trade brings three main economic gains: product variety competition specialization Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Absolute and Comparative Advantage Specialization can be based on either absolute advantage or comparative advantage. Absolute advantage is exhibited by a producer who can supply a certain quantity of an item more efficiently than can other producers. Comparative advantage is exhibited by a producer who can supply a certain item with a lower opportunity cost than can other producers. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Gains from Trade Based on Absolute Advantage Figure 15.4, Page 410 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Lawyer20 hours2 hours20 – 2 = 18 hours Carpenter5 hours10 hours10 – 5 = 5 hours Time Spent Building Furniture Time Spent Preparing a Will Time Saved through Specialization

Gains from Trade Based on Comparative Advantage Figure 15.5, Page 411 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Canada12 tonnes12 computers1.0 computer1.0 tonnes paper Mexico3 tonnes9 computers3.0 computers0.33 tonnes paper PaperComputers of 1 tonne of paper of 1 computer Hypothetical Output Per Worker Opportunity Cost

Total Gains from Specialization Figure 15.6, Page 412 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Canada60 tonnes60 computers120 tonnes0 computers Mexico30 tonnes90 computers0 tonnes180 computers 90 tonnes150 computers120 tonnes180 computers PaperComputersPaperComputers Before TradeAfter Trade

The Impact of Trade Protection (a) In a perfectly competitive market: a tariff (which is an excise tax on imported goods) decreases consumption and foreign imports, while it increases domestic production and government revenues an import quota (which is a non-tariff barrier) has the same effect as a tariff, except that the increase in government revenues is replaced by an increase in the price of foreign imports Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The Impact of Import Barriers Figure 15.7, Page 415 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Quantity (thousands of bicycles per year) Price ($ per bicycle) Tariff Quantity (thousands of bicycles per year) Price ($ per bicycle) Import Quota S d0 S i0 S i1 S1S1 D D f g a b c d e

The Case for Trade Protection Seven arguments are used to support trade protection: domestic employment infant industries terms of trade environment and safety standards cheap foreign labour national security cultural sovereignty Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Average Tariff Rates in Canada Figure 15.8, Page 414 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

The End Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 5 th edition by Mark Lovewell