Question 1: Impact of FDI (15 marks)
Following the slow down in productivity in Canadian manufacturing during the 1990s and the
signing of NAFTA in 1994 there were large capital outflows (FDI) that moved from Canada into
the United States and Mexico. All countries produce two goods: a manufacturing good (M) and
an agricultural good (A). Manufacturing is capital intensive and uses labour and capital in both
the short and long run. The agricultural good is labour intensive and requires labour and land in
the short run but switches to capital and labour in the long-run.
(a) Using the Specific-Factors Model graph the short-run impact in Canada from the capital
outflows. Describe and explain the following:
(i) impact on the wages of workers.
(ii) impact on capital owners and land owners.
(iii) changes in the allocation of resources between industries and production.
(b) Using the Heckscher-Ohlin Model graph the long-run impact in Canada from the capital
outflows. Describe and explain the following:
(i) impact on the wages of workers.
(ii) impact on capital owners.
(iii) changes in the allocation of resources between industries and production.
(c) Using the imperfect competition model discuss which Canadian firms were most affected by
the capital outflows that occurred during this time?
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Question 2: Gains from Variety (15 marks)
(a) Countries import and export goods in very fine goods classification. For example, Canada
imports and exports apples to and from the United States.
(i) Explain why the Ricardian Model and Heckscher-Ohlin Model of Trade cannot explain
this type of trade.
(ii) What assumptions in the imperfect competition model of trade help explain why countries will import and export the same good, e.g. apples?
(b) Using data from UN Comtrade:World Bilateral Trade find two combinations of countries
trading two different HS6 classification goods. (Example Canada trading with the USA in
apples and Mexico trading Brazil in digital wrist watches).
(i) Compare the level of sustainability/degree of differentiation within these two product
categories. Explain your answer.
(ii) Imagine that tariffs are introduced by the same amount for the two goods between the
two countries. Can we know which tariff increase will hurt consumers more? Explain your
answer.
(iii) How will bilateral trade be affected between the two countries following the tariff
introduction? Will the drop in bilateral trade be the same? If not, which good will be more
severely affected? Explain your answer.
Sample Solution
