The Production Possibilities Frontier

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1. A reduction in trade barriers has two effects on the economy. The production possibilities frontier will move outward, and the economy will move closer to the production possibilities frontier. Both outcomes are related. Freer trade creates more markets for the country for its goods and services. This allows companies to produce more, but it does not directly change the production capacity of the nation. Thus, the economy moves closer to the production possibilities frontier (Rittenberg & Tregarthen, 2009). The reason that the production possibilities frontier also moves owes to the theory of comparative advantage. Freer trade allows the country to focus production on those goods and services in which it has comparative advantage. Thus, the economy's production becomes more efficient. Given that the factor resources (people, capital) have not changed, an increase in efficiency will push the production possibilities frontier outward. This is because the total capacity is going to be higher. Note that there is a difference between producing the same things more efficiently, and producing goods that are more efficient. The total capacity of the economy is changed when the mix of product and services is changed, marking a shift in the curve to go along with moving production closer to the curve. In addition, trade encourages technological transfer. Firms in each country learn from one another, and the transfer of knowledge and technology is one way that this occurs.
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