It is a fact that no individual can be self-sufficient. Everybody needs the input of external parties to live comfortably. Similarly, countries also need the help of other countries since no country can be self-sufficient. Countries need to import goods that they do not have the capacity of producing. Therefore, free trade encourages specialization of countries. Specialization increases the production capabilities of countries, thereby facilitating economic growth. To facilitate free trade, countries need to reduce regulations that restrict free trade. Formation of the European Union is one of the boldest attempts to increase trade between the EU member states, and therefore, facilitate economic growth of the member states. Despite having vast benefits, free trade also has various limitations that may harm a country’s economy. Therefore, it is vital for countries to undertake extensive research before deciding whether to engage in free trade.
Production of various goods and services requires the presence of factors of production. These are labor, natural resources and capital. Scarcity of the factors of production necessitates their use in the most efficient manner. Factors of production may favor the production of certain goods and services. This necessitates the use of the factors of production in making goods and services that make optimum use of the factors of production. This would enable a company or country to move closer to its production possibilities curve. Production possibilities curve is the maximum combination of products that a country or company can produce using similar resources. Reduction in trade barriers of EU member states facilitates specialization of EU member states in areas where they have comparative advantage, while importing products that they are incapable of producing efficiently. Specialization increases the production capabilities of EU member states enabling them to move closer to their product possibilities curve. Specialization also enables nations to invest more in producing specific products.
In most instances, nations operate inside their product possibilities curve. This is because it is hard for a nation to use all its resources effectively. Idle capital, labor or natural resources make a nation operate within its production possibilities curve. This inhibits a nation from attaining its production potential. Unemployment is one of the major reasons that make nations operate inside their production frontier. Nations that operate inside their production possibilities curve can move closer to their production possibilities curve without incurring any opportunity cost. This is because the factors of production were previously idle, prior to their use in production.
The production possibilities curve portrays a nation’s production capabilities. Therefore, an outward shift of the production possibilities translates to economic growth of the country. Increases in resources would result in an outward shift of the production possibilities curve. Increase in resources would increase a nation’s capability of producing goods and services (Taylor, 2006). An example is a nation that makes a discovery of vast amounts of oil. Oil would increase the sources of energy of the nation and provide more income when the country exports it. Improvement in technology would also lead to an outward shift in the production possibilities curve. Improvement in technology would facilitate production of more goods and services (Carbaugh, 2010).
Technological improvement and increase in natural resources lead to an increase in the living standards of residents of the country. However, an outward shift of the production possibilities curve does not necessary translate to improvement in the living standards of residents of the country. The production possibilities curve may shift outwards due to population growth. This does not lead to improvement in the living standards of residents of the country as it generates more mouths to feed (Bernanke, 2003). In fact, population growth leads to a decline in the living standards as people begin to put more pressure on the scarce resources. However, population growth leads to gains in human capital, which may increase the production possibilities of the country.
Opportunity cost accompanies any production decision. Economists strive to make a production decision that would lead to minimal opportunity costs. Producing a good or service that results in minimal opportunity cost makes a company or country have a comparative advantage. Formation of the EU enabled countries to specialize in activities that would make them have comparative advantage. Therefore, formation of the EU enabled certain nations – such as Germany – to specialize in the production of high-end products whereas other nations such as Portugal specialized in the production of cheap products. Countries that specialize in production of high-valued products have high-income levels whereas countries that specialize in the production of cheap products have low incomes (Thompson, 2001). However, by specializing in cheap products, the EU member states did not reduce their income levels. These nations had low incomes even before the formation of the EU. Formation of the EU enabled the nations increase their incomes. In addition, nations that specialize in the production of high-end products had high levels of income even before the formation of the EU. However, the EU has enabled them to improve their income levels significantly.
Free trade has many benefits to any nation. Free trade leads to increased production. As the EU has shown, free trade enables a nation to specialize in products in which it has a comparative advantage. Specialization enables nations to improve their efficiencies through increased output and economies of scale. Free trade also enables consumers to gain access to a variety of products. Increase in the variety of products increases competition leading to improvement in the quality and reduction in price of the products (Carbaugh, 2010). Free trade also leads to foreign exchange gains. Exports enable countries to receive foreign currencies. The country may use the foreign currencies to pay for imports.
However, free trade may also harm a country’s economy. Free trade may make countries with surplus products dump them in other countries at very low costs. This creates an unfair competition in the market. This ultimately leads to collapse of companies that are unable to cope with the competition from the cheap imports. The competitive industry may also inhibit the establishment of local industries. This necessitates governments to institute legislation that protects local industries (Boone & Kurtz, 2012). The other major limitation of free trade is that it makes a nation prone to instabilities in the international trade cycles. Economic downturns in other nations would affect the country significantly. This was evident in the global financial crisis where the economic downtown of the US affected other countries significantly.
The aim of every nation is to increase its production possibilities. Nations can only achieve this by using their resources effectively. Countries strive to channel resources to areas where there would be efficient use of the resources. Determining the most efficient field to channel the resources is one of the most difficult economic decisions. This decision ultimately determines whether a nation would have a free market, socialist or mixed economy.
References
Bernanke, B. (2003). Principles of macroeconomics. Beijing: McGraw-Hill Education (Asia) Co.
Boone, L.E. & Kurtz, D.L. (2012). Contemporary marketing, 2013 Update. Belmont, CA: Cengage Learning.
Carbaugh, R.J. (2010). Contemporary economics: An applications approach. Edmonds, WA: M.E. Sharpe.
Taylor, J. (2006). Principles of macroeconomics. Belmont, CA: Cengage Learning.
Thompson, G. (2001). Governing the European economy. London: Sage Publications Ltd.