Production possibilities curve: scarcity, opportunity cost, and efficiency

Economics

The production possibilities curve represents the maximum level at which a country can produce. Freer trade, such as what the EU has promoted since its inception, allows countries to do two things. The first is that it allows them to produce at their production possibilities curve. This occurs because the country under free trade conditions is going to produce those goods in which it has a comparative advantage. This improves the efficiency of production because the country is producing goods at which it is better at producing, and as it produces more of those goods than it otherwise would the country will also have better economies of scale. A country will produce at a higher level of efficiency after free trade than it did before, bringing it closer to the production possibilities curve.

The other thing that happens under free trade is that the production possibilities curve is that it gets pushed outward. The improved efficiency from free trade is likely to increase the production capacity of the nations engaged in the trade. As a result, not only with the countries involved meet their old production possibilities curve, but they will see their production possibilities curves move as well.

2. An economy that is operating inside its production possibilities frontier is not operating at its capacity. There are issues within that economy with respect to efficiency. This economy should be able to increase production of any good at this point, a new good or existing one, because there is unused productive capacity in the economy. The country has resources that are being unused (Investopedia, 2011). If those resources are used, then the country will be in a position to experience economic growth up until the point where the production reaches the production possibilities frontier.

3. There are a number of reasons that the production possibilities frontier is pushed outward. Two of the main ones are improvements in technology and the exploitation of more resources (Riley, 2006). The first of these, improvements in technology, will push the production possibilities frontier outward by allowing the country to make better use of the resources that it has. The production possibilities frontier is a function of both the resources that the country has available and the ability of the country to leverage those resources. So if the country has increased its ability to leverage its resources by way of improving its technology, then that country will its production possibilities frontier move outward to reflect that increase in productive capability.

The other way that the production possibilities frontier is expanded outward is by the exploitation of more resources. In some cases, there is a natural increase in the resources available to the country, such as an expanding workforce. In other cases, new uses are found for pre-existing resources. An example of this might be putting solar panels in the desert -- the sunlight was always there but now it is being put to use in generating economic activity whereas before it was not.

Since the Industrial Revolution, both of these factors can explain our steady and strong economic growth. A rapidly increasing population and evolving technology have combined to not only give us more resources, but has improved our ability to exploit the resources we have. New technology puts existing resources -- stocks of oil and minerals in particular -- to better use. Combining these two factors we see a dramatic increase in the production possibilities frontier in most of the world's countries in the past couple hundred years.

4. Comparative advantage has played a major role in the increase in trade between EU member nations. There is evidence that nations within the EU have enjoyed economic expansion in part because of leveraging comparative advantage in trade with each other (Weihrich, 1999). Nations have become more specialized since the advent of the Union.

With the advent of the EU, nations within the Union have all but eliminated trade barriers between them. As a result, nations have taken to increased specialization, and this has resulted in each European nation leveraging comparative advantage. The result is dramatically increased trade between the nations of the European Union since its inception (Rittenberg & Tregarthen, 2010).

The effect that this increased trade has had on the standard of living enjoyed by member nations of the EU is that the standard of living has increased in European nations since the inception of the EU. The increased efficiency and specialization allows these nations to use their resources more effectively, and this pushes the production possibilities frontier outward. As the production possibilities frontier is pushed outward, this represents an improvement in the wealth of the EU nations. This increased wealth has, over the past decades, translated to increased living standards. This becomes clear when studying the effects of the EU compared to the economies of the Eastern bloc nations -- the living standards in West Germany were much higher than those in East Germany and the expansion of the production possibilities frontier was a major reason for that.

5. There are many advantages of free trade. Clearly, free trade encourages specialization according to the principles of comparative advantage. As a result, nations become more efficient, trade increases and standards of living improve. These benefits have accrued to most nations that have pursued free trade policies.

There are disadvantages to free trade, however. One argument against unbridled free trade is that it can promote economic inequality. Nations with comparative advantages primarily in low value goods may focus production on those goods, but there is a difference in the long-term growth effects in producing bananas vs. producing automobiles -- and free trade can sometimes lead nations to have difficult gaining any sort of comparative advantage in the trade of high-valued-added goods, ultimately lowering the level of economic growth in that economy.