Why does everything cost more in Canada?

-- Natalie Cocozza, 12, Annandale

Actually, most things don't cost more in Canada -- it just seems like they do.

The confusion comes about because both Canadians and Americans call their money by the same name. But the Canadian dollar and the U.S. dollar do not have the same value, just as the U.S. dollar and the French franc don't have the same value. To compare prices from one country to another, you first have to do some arithmetic and convert Canadian prices into U.S. dollars and cents.

If you go to a bank and try to exchange your U.S. dollar for Canadian money, for example, the bank will give you one Canadian dollar -- or "loonie" as they call it -- plus 58 Canadian cents. Suddenly, those expensive Canadian backpacks wouldn't look so expensive. Or going the other way, if a Canadian were to come to Washington, she would get only 63 U.S. cents for every one of her loonies. Then those "cheap" American shoes wouldn't look like such a bargain.

This "exchange rate" isn't set by the banks or by the government. It is determined by millions of people and businesses every day who have a reason to trade one currency for another, on currency exchanges that work much like the stock market. If, on a given day, more people want to buy loonies than U.S. dollars, the value of the loonie goes up against the U.S. dollar. If more people want to buy dollars than loonies, the U.S. dollar goes up. The changes usually amount to a fraction of a penny on any given day.

If the exchange rate is right, then the price for a pair of Levi jeans at a store in Buffalo, New York (say, 35 U.S. dollars) should be roughly equivalent to the price of the same jeans just across the border in Hamilton, Ontario (55 Canadian dollars). And if for some reason they aren't equivalent, then they will be before too long. That's because some smart people would come along and buy lots of "cheap" jeans in Hamilton, drive them over the border, and sell them in Buffalo at the higher price, making an easy profit on the difference.

So many people would do that, in fact, that pretty quickly a shortage of jeans would develop in Hamilton, driving up the price there, while a jeans glut would develop in Buffalo, driving down the price there. And this would go on until the two prices would end up roughly equivalent in both places.

Of course, not everything works out so neatly. There can be rather large differences in prices for goods and services that can't easily be moved across borders -- land, for example. And prices for many things in Canadian stores are higher because of the higher sales taxes there. But when countries are close to each other and have roughly the same standard of living, like the United States and Canada, prices for most things track pretty closely, once the exchange rate is factored in.

-- Steven Pearlstein