"Production Possibilities CurveIntroduction:Economics is sometimes called the study of scarcity. The basic economic problem deals withscarcity and choices - resources are limited but people wants are unlimited. People have to makechoices from scarce resources to satisfy their wants. Scarcity and choices are the main idea thatlies at the centre of economics. Production possibility frontier is a key concept in economics.Production Possibilities Frontier: The production possibilities frontier (PPF) shows the maximum possible combinations of goodsand services that an economy can produce given a certain amount of resources that are fullyemployed with a given technology. The points on the PPF denote efficiency and imply thatresources are utilized efficiently. As we know the resources are scarce and they are fullyemployed, increase in the production of one good is possible by producing fewer amounts ofother good. This is called as opportunity cost or forgone cost.The PPF curve is concave shapedue to increasing marginal opportunity cost. Let us assume a country, with its available resources produces two goods like capital goodsand consumption goods. This is shown by the following PPF.PPF In the above PPF, if the economy needs to produce more units of consumption goods, say tomove from point A to point B, it should forgo some amount of capital goods. So, there exists atradeoff between the two goods and more production of one good is followed by increasingopportunity cost. Removing the Trade barriers and PPF:Removing the trade barriers will help to the countries to have more of the good which it is unableto produce domestically. Thus by reducing the trade barriers or by promoting the free tradepolicies the PPF can move outwards.A case of European Union The European Union (EU) was created in November 1993 and emerged as a single marketsystem that facilitates free mobility of goods and services, capital and human resources. The EUincorporates universal policies for trade and regional development among the member countries. In EU about 16 member countries has agreed to follow a general currency Euro, representing theEuro zone and thereby lowers the risk for Euro – area businesses. Since its launch in 1999, theEuro has slowly but gradually made its mark in the international market. As a result trade amongall the members of EU has increased tremendously. The northern part of EU like France andGermany tended to specialize in the high valued goods like office equipments or electrical goodswhere as the countries in Southern part specialized in food and clothing. Ultimately all themember countries gain from this specialization due to free trade .Thus removing the tradebarriers has increased the welfare of the people throughout the Union (Rittenberg L. and T.Tregarthen 2009). Operating inside the PPF: If any economy operates inside the PPF (like point A in the above graph), it means the economyis productive inefficient. In other words the economy is unable to utilize its resources efficiently.No economy should operate inside any point of the PPF as it depicts the productive inefficientpoint. With the reallocation of resources the economy can utilize the resources efficiently andcan move to the points on the PPF. Shifting the PPF outwards:Production possibility frontier shifts outward due to following reasons:1. The outward shift of the PPF could occur due to the economic growth that allows moreproduction on capital goods and the consumer goods. In other words more productivity ofboth the goods will shift the PPF outwards.2. Another factor that will cause the production possibility frontier to shift outward is thetechnological growth. Any new discovery or the exploitation of natural resources also causes the PPF to shift outwards.Absolute and comparative advantage:Absolute advantage refers to the capacity of a nation to produce any goods or services at a lowercost or with higher productivity. Absolute advantage compares industry productivities acrosscountries. Some countries have an absolute advantage in the production of many goods whilesome countries do not have absolute advantage in any goods compared to other countries. Comparative advantage implies the ability of a country to produce goods and services at a loweropportunity cost than its trading partners. The opportunity cost of a good is the quantity of othergoods sacrificed to make an extra unit of that good. So, countries will try to specialize in theproduction of those goods in which it has comparative advantage (Torstein Jochem).Comparative advantage: a hypothetical example Comparative advantage is considered as the basis of international trade. Let us consider ahypothetical world of two countries, Country X and the Country Y, who produce peaches andbananas. Country X's and Country Y's hourly productivity are as follows: Bananas/hour Peaches/hourCountry X 6 4Country Y 3 1Country X has the absolute advantage on both bananas and peaches as country X can producemore of both the gods per hour than country Y. But in order to find out the comparativeadvantage we have to calculate the opportunity cost. Country X: 4 peaches = 6 bananas or 1 peach = 1.5 bananas Thus in order to produce 1 peach, country X has to forego 1.5 bananas.Similarly,6 bananas= 4 peaches or 1 bananas = 0.66 peachesThus in order to produce 1 banana, country X has to forego 0.66 peaches. County Y: 1 peach = 3 bananas Thus in order to produce 1 peach, country Y has to forego 3 bananas.Similarly, 3bananas= 1 peaches or 1 bananas = 0.33 peachesThus in order to produce 1 banana, country Y has to forego 0.33 peaches. The opportunity cost is less in country X for peach and thus it has a comparative advantage inpeach production. The opportunity cost for banana is less in country Y and thus it has acomparative advantage in banana production. After specialization: Bananas/hour Peaches/hourCountryX 0 8CountryY 6 0Totaloutput6 8If country X produces only peaches it will produce If both specialize in the goods in which they have comparative advantage, Country Y willproduce only bananas and no peaches.Country Y will produce 6 bananas and no peaches.Country X will produce 8 peaches and no bananas.The world production for peaches will increase. Moreover if the terms of trade lie between thetwo opportunity costs then both the country will be benefitted. "