Foreign Service Officer Test (FSOT) Practice Exam

When economies are closed off from international markets, what critical inefficiencies occur?

1. Local producers become less innovative

2. Resources are wasted on artificially created markets

3. Trade relationships weaken

4. Prices decrease significantly

The correct answer is: Resources are wasted on artificially created markets

When economies are closed off from international markets, critical inefficiencies indeed arise, particularly in how resources are allocated and utilized. In a closed economy, domestic producers are shielded from international competition, which can lead to the misallocation of resources. Specifically, resources might be wasted on artificially created markets because domestic industries may not face incentives to invest in efficiency or innovation. Without the pressure to compete globally, companies can become complacent, leading to overproduction in certain sectors and underproduction in others where there might actually be demand if trade were allowed. This inefficiency results from a lack of specialization and the failure to benefit from comparative advantage, which typically enhances productivity and optimizes resource use in an open economy. Although the other options highlight consequences that can occur in a closed economy, they do not encapsulate the overarching issue of resource allocation and inefficiencies. For instance, while local producers may indeed become less innovative due to a lack of competition, this is a secondary effect of the larger issue of inefficient resource use. Similarly, while trade relationships may weaken and prices may be affected, these factors are related to the inefficiencies but do not directly illustrate the critical misallocation of resources that occurs in isolation from international markets.