Thinking Like An Economist - Essay Example

Thus, trade barriers will reduce market efficiency. The reason is simple that the comparative advantage that is there in free trade system will be lost and the economies will have to produce each and everything for themselves which will not allow for specialization and the benefits gained from it. Each country has specific resources in form of labor, capital, technology and knowledge (skill) and these resources can be used to produce certain type of goods better than other type of goods. Thus, if each country is able to recognize what it can produce best, the whole world will benefit by producing only what it excels others at producing and exchanging that with nations that produce other things that they excel at thus allowing for larger number of each good produced for the same amount of resources.

Other positives of free trade system include greater variety of goods and services, efficient use of the scarce resources and a greater competition for the domestic industry. Therefore, we can say that since having trade barriers causes the economy to produce inside its maximum potential with given amount of resources, that is, the production possibilities frontier, a reduction in trade barriers would mean production moving closer to the production possibilities frontier. . Q.2) An economy that is producing inside the production possibilities frontier is not realizing its full potential and there is a room for betterment.

Such a situation, where the economy does not operate at its full potential arises in two situations: 1) when the economy is unable to employ all its resources of production, for example, labor available but not employed; 2) misallocation of resources. The production possibilities frontier tells us the maximum quantity of two products that can be produced using the current amount of resources. However, if available resources are not fully utilized, the output will be less than the full potential.

Using 4 out of 5 machines available due to fuel shortage can be another example of underutilization of available resources. Misallocation of resources happens when an economy starts producing goods that it does not specialize in. This will require the particular nation to use comparatively more resources to produce the same amount of that good than a nation who has comparative advantage in producing that good. Had the nation employed the same resources in producing the other goods that it specializes in, the economy would have been better off by being on or closer to the production possibilities curve.

The inefficient use of resources implies that the economy could be producing more without adding a single unit of labor or capital by allocating resources efficiently on the basis of comparative advantage (Tregarthen & Rittenberg, Chapter 2: Confronting Scarcity: Choices in Production, 2009). Q.3) Economic growth refers to the state where the production possibilities curve of an economy expands or shifts outwards. This means that the economy is able to produce more with the given amount of resources than it