Open economy

An open economy is an economy in which there are economic activities between the domestic community and outside. People and even businesses can trade in goods and services with other people and businesses in the international community, and funds can flow as investments across the border. Trade can take the form of managerial exchange, technology transfers, and all kinds of goods and services. (However, certain exceptions exist that cannot be exchanged; the railway services of a country, for example, cannot be traded with another country to avail the service.)

It contrasts with a closed economy in which international trade and finance 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. Exporting and importing are collectively called international trade.

There are a number of economic advantages for citizens of a country with an open economy. A 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 the country. There are also economic disadvantages of opened economy. 1. Open economy are interdependent on other economics and this exposes them to certain unavoidable risk.

If a country has an open economy, that country's spending in any given year need not 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]As of 2014 there is no totally-closed economy.

Economic models

The basic model

In a closed economy, all output is sold domestically, and expenditure is divided into three components: consumption, investment, and government purchases.

                       Y = C + I + G

where Y is the national income, C is the total consumption, I is the total investment and G is the total government expenditure. In an open economy, some output is sold domestically and some is exported to be sold abroad. We can divide expenditure on an open economy’s output Y into four components: Cd, consumption of domestic goods and services, Id, investment in domestic goods and services, Gd, government purchases of domestic goods and services, X, exports of domestic goods and services. The division of expenditure into these components is expressed in the identity

                   Y = Cd + Id + Gd + X.

The sum of the first three terms, Cd + I d + Gd, is domestic spending on domestic goods and services. The fourth term, X, is foreign spending on domestic goods and services(the value of exports). Since total domestic spending is a sum of spending on domestic as well as foreign goods and services, we can say that,

            C = Cd + Cf, I = I d + I f, G = Gd + G f.

We substitute these three equations into the identity above: Y = (C − Cf ) + (I − I f ) + (G − G f ) + X. We can rearrange to obtain

            Y = C + I + G + X − (Cf + I f + G f).

The sum of domestic spending on foreign goods and services (Cf + I f + G f) is expenditure on imports (IM). We can thus write the national income accounts identity as

                  Y = C + I + G + X − IM.

Since the value of total imports is a part of domestic spending and it is not a part of domestic output, it is subtracted from the total output.This gives us the value of Net Exports (NX = X − IM), the identity becomes

                    Y = C + I + G + NX.

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

If output exceeds domestic spending s, we export the difference: net exports are positive. If output falls short of domestic spending, we import the difference: net exports are negative.