In chapters 3 and 7, we saw how the elimination of trade barriers, whether they were transparent tariff barriers or opaque non-tariff barriers, affects the flow of goods and services among countries. The underlying assumption in the economic theory we used is that goods and services are traded but the factors of production responsible for producing them – capital, labor, and land – remain fixed in each country and do not move across their respective national borders. For labor and capital to be allocated efficiently across regions within each country that is part of an economic union, however, they must be allowed to move freely from one location to another. If each factor moves to where it can receive the highest return within an economic union, then total output for the union as a whole will be maximized. Only with the free movement of the factors of production across the borders of the member states can total output for the economic union reach its full potential.

Figure 8.1 illustrates this reasoning by contrasting the situation for labor as a factor of production in West Germany and Italy during the economic miracle period of the 1950s (the period is described in more detail in chapters 12 and 15). The demand for labor in each country is determined by the marginal product of labor (MPL in the figure).