Open Economy

Introduction to Economy and Concepts of Trade

Objective

After going through this lesson, you shall be able to understand the following concepts.

• Introduction to Economy- Closed and Open Economies
• Benefits of Open Economy
• Difference between Closed and Open economies
• Trade Agreements- Bilateral and Multilateral
   

Introduction

"Economy" is used to refer to countries in economics. It is defined as a framework that consists of an economic system which allocates the scarce resources to the consumption, production, investment and saving activities. Basically there are two types of economies- closed economy and open economy. A closed economy is that economy which does not trade with other economies in terms of goods and services and operates within itself only. In such a economy, imports and exports are prohibited. On the other hand, an open economy is that economy, which trades with other economies (or rest of the world) in terms of goods and services. It can also engage in activities such as borrowing and lending and other such activities with the rest of the world. In other words, an open economy involves exchange of goods and services and monetary transactions with the economies of the rest of the world. An open economy's political functions as well as the economic functions are in sync with the happenings in the world.

Benefits of Open Economy

With the advent of globalisation, today almost every economy in the world is an open economy. This is because of the various benefits associated with the opening-up of an economy. Some of the advantages (benefits) of an open economy are as follows.

1. An open economy engages in the export and import of goods and services with the rest of the world. Thus, the consumers can choose rationally from a greater pool of goods and services to maximise their satisfaction.

2. Similar to the consumers, the investors also enjoy the benefit of choosing from a wide range of assets and securities. Thus, they enjoy greater investment opportunities to maximise their returns.

3. Besides the freedom of choice in terms of goods and services and investment, firms and workers also enjoy the option choosing the location of production and work. The workers and firms can migrate from one country to another country in order to avail the best suited opportunity.
 

Difference between Closed and Open economies

Let us now study the tabular difference between closed and open economies.
 

Basis	Closed Economy	Open Economy
1. Meaning	A closed economy does not trade with other economies in terms of goods and services and operates within itself only.	An open economy trades with other economies in terms of goods and services.
2. Economic relation	There is no economic relation with rest of the world.	There exists economic relation with rest of the world.
3. Concept	It is an imaginary concept in today's world.	It is a realistic concept in today's world.
4. Affected by	Economic activities of other economies/countries do not affect closed economy.	Economic activities of other economies/ countries affect open economy.
5. GDP and GNP	Gross Domestic Product and Gross National Product are equal to each other in case of closed economy.	Gross Domestic Product and Gross National Product may be different in case of open economy.

Trade Agreement- Bilateral and Multilateral

Trade agreement refers to a legally binding arrangement between nations/countries stating their trade relations. In an open economy, trade agreements can be of two types. These are as follows.

1. Bilateral trade: It is a trade agreement between t…