Open economy

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An open economy is an economy in which people, including businesses, can trade in goods and services with other people and businesses in the international community at large. This contrasts with a closed economy in which international trade cannot take place.

The act of selling goods or services to a foreign country is called exporting. The act of buying goods or services from a foreign country is called importing. Together exporting and importing are collectively called international trade.

There are a number of advantages for citizens of a country with an open economy. One primary advantage is that the citizen consumers have a much larger variety of goods and services from which to choose. Additionally, consumers have an opportunity to invest their savings outside of the country.

In an open economy, a country's spending in any given year need not to equal its output of goods and services. A country can spend more money than it produces by borrowing from abroad, or it can spend less than it produces and lend the difference to foreigners.^[1]

Economic models of an open economy

The basic model

The basic economic model of an open economy is the same as that of a closed economy model except two new terms are added: Exports (EX) and imports (IM):

Y = C^d + I^d + G^d + EX

Y = C + I + G + (EX-IM)

With Y being gross domestic product / national income, C^d is consumer consumption of domestic goods and services, I^d is investment in domestic goods and services, G^d is government expenditures on domestic goods and services. The term (EX − IM) is usually called net exports and is sometimes designated with the term NX.

In closed economy: National savings= Investment. Closed economy countries can increase its wealth only by accumulating new capital.

See also

• Exchange rate
• Terms of trade

Open Economy is that in which external environment involved is called open economy.

Footnotes and sources