Open Economy

October 13, 2010More Economicsby EconomyWatch

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An Open Economy is an economy, which is free to trade with the other economies of different countries. This is in sharp contrast with the closed economy where people are not allowed to trade with other countries. An open economy is a field, which deals in macroeconomic phenomena like exchange rates, balance of trade, tariffs, subsidies, and import quotas. An open economy is advantageous because people can trade in goods and services; indulge in business with the international arena at large. This increases the scope of trade and business leading to profitable earnings.

An open economy comprises of two types of trade. They are:

  • Export
  • ImportExport is the act of selling goods and services to a foreign country. Import is the act of purchasing goods and services from a foreign country. These two are collectively termed as international trade.

    Advantages of Open Economy

    There are quite a few advantages of an open economy. They are:

  • The primary advantage is that the consumers can choose from a large variety of goods.
  • An open economy increases the opportunity of direct foreign investment.
  • Another benefit of an open economy is that it is more flexible.
  • An open economy has a greater chance of adjusting itself with the changes taking place in world economy.
    The basic model of an open economy is given below:
    Y= Cd + Id + Gd + (EX-IM)
    Where Y stands for the income level, Cd stands for the consumption of domestic goods and services by the consumers, Id stands for the investment on domestic goods and services, Gd stands for government expenditure in domestic goods and services. Net Export is equal to (EX-IM) and is occasionally termed as NX.

    Most of the countries in the world follow the open economy since the world has become a global village.

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