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Closed Economy and Open Economy: Features and Types of Open Economy

EPOS-Eco

Published on: December 23, 2020

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Closed and Open Economy

On the basis of economic relationship or participation in international trade, we can divide economies of the world into two types which are closed economy and open economy.

(1) Closed Economy

In a closed economy, there is no trading activity with outside economies.

The closed economy is entirely self-sufficient economics.

There are no imports or exports with other countries in closed economy.

The goal of a closed economy is to provide everything domestic consumers what they need.

Such type of economy is completely self-sufficient and often backward or underdeveloped because such economy has to depend on the raw materials, skill and technology, which are available within the country.

The concept of closed economy is only theoretical because such economy is not in existence in the real world.

All the countries of the world are involved in external trade i.e. export and import.

A government may close off a specific industry from international competition.

Self-sufficiency is not possible in the modern world.

Keep in Mind

Example of a closed economy:

In practice, there are no completely closed economies.

Brazil imports the least amount of goods.

Import goods is least in the gross domestic product (GDP)

Brazil is in the world’s most closed economy.

Brazilian companies face challenges in competition with other countries’ companies.

They also face difficulty in exchange rate appreciation and defensive trade policies.

In Brazil, only the largest and most efficient companies can import and export.

There are various definitions of closed economy given by the economists, which are as follows:

According to NG Mankiw, “Closed economy is an economy that does not interact with other economies of the world.”

According to PA Samuelson and WD Nordhaus, “An economy that does not engage in international trade (i.e. imports and exports) of goods and capital with other countries.”

Thus, the closed economy is that economy which does not import and export or does not have any economic relationship with other countries of the world.

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Features of Closed Economy

Some important features of the closed economy are as follows:

a.	A closed economy has no economic relation with the rest of other countries.
b.	Neither goods nor services are imported or exported to the foreign countries.
c.	Neither borrows nor lends loan with the foreign countries.
d.	It neither takes foreign aid nor gives aid to the other countries.
e.	A citizen of a closed economy cannot go to the other countries to work and foreigners are also not allowed to work in the domestic countries of the closed economy.
f.	Since income received from abroad and income paid to foreigners are zero GDP and GNP of the closed economy are equal.

Types of Closed Economy

The closed economies can be divided into the following two types:

(A) Two-sector economy

The closed economy which consists of only household and business sectors is called two-sector economy.

There are no government and foreign sectors or import and export in the two sector economy.

This is totally a hypothetical concept.

In this economy, GDP is the sum of consumption expenditure made by household sector and investment expenditure made by the business sector.

Symbolically,

GDP = C + I

Where:

GDP = Gross domestic product

C = Consumption expenditure

I = Investment expenditure

(B) Three-sector economy

The closed economy which consists of household, business and government sectors is called three-sector economy.

There is no foreign sector or import and export in the three-sector economy.

This is also hypothetical or theoretical concept.

In this economy, GDP is the sum of consumption expenditure made by the household sector, investment expenditure made by the business sector and government expenditure.

Symbolically,

GDP = C + I + G

Where:

GDP = Gross domestic product

C = Consumption expenditure

I = Investment expenditure

G = Government expenditure

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(2) Open Economy

An economy which participates in the international trade is called open economy.

In open economy, trades not only do the business within its own country but also involves in export and import of goods and services.

Such type of economy is also known as the four-sector economy because this economy consists of four sectors: household sector, business sector, government sector and foreign sector.

In this economy, gross domestic product is the sum of consumption expenditure, investment expenditure, government expenditure, investment expenditure, government expenditure and net export.

Net export is the difference between the value of total export and the value of total import.

Symbolically,

GDP = C + I + G (X – M)

Where:

GDP = Gross domestic product

C = Consumption expenditure

I = Investment expenditure

G = Government expenditure

X = Export

M = Import

X – M = Net export

In the modern era, all economies of the world are open economies.

These economies are interdependent with each other.

They import and export raw materials, labour, technology, capital etc.

No country in the world can be self-dependent.

This is realistic or actual situation of the modern world.

The degree of openness of the economies is increasing due to the increasing globalization of the world.

The degree of openness of a country is measured by the ratio of volume of trade and GDP.

There are various definitions of open economy given by the economists, which are as follows:

According to GN Mankiw, “Open economy is an economy that interacts freely with other economies around the world.”

According to PA Samuelson and WD Nordhaus, “An economy that engages in international trade (i.e. imports and exports) of goods and capital with other countries.”

Thus, the open economy is that economy which imports and exports goods and services or has economic relation with other countries of the world.

Features of Open Economy

Some important features of the open economy are as follows:

a	An open economy has economic relation with the rest of the world.
b	An open economy imports and exports goods and services or has trade relation with the other countries of the world.
c	An open economy borrows from the other countries and also lends to other countries.
d	An open economy takes foreign aid from the other countries and also gives aid to the other countries.
e	A citizen of an open country can go to the other countries to work and foreigners are also allowed to work in the domestic territory of the open economy.
f	It sends gifts and remittances to the foreigners and receives the same from them.
g	Since citizens of the open economies receive income from abroad and pay income to the foreigners, GDP and GNP are different.

Differences between Open Economy and Closed Economy

Bases	Open economy	Closed economy
Economic relation	An open economy has economic relation with the rest of the world.	A closed economy has no economic relation with the rest of the world.
Import and export	An open economy is involved in import and export of goods and services.	A closed economy is not involved in import and export of goods and services.
Borrowing and lending	An open economy borrows and lends.	A closed economy neither borrows nor lends.
Foreign aid	An open economy takes and gives foreign loan.	A closed economy neither takes nor gives foreign loan.
Movement of workers	An open economy allows inward and outward movement of the labour or workers.	A closed economy does not allow inward and outward movement of the labourer or workers.
Remittance	An open economy receives remittances.	A closed economy does not receive remittances.
Realistic and theoretical	All the economies of the world are open economies. This is a realistic concept.	There is no closed economy in the world. This is only a theoretical concept.
Equality between GDP and GNP	In this economy, GDP and GNP are different.	In this economy, GDP and GNP become equal.