Introduction to Closed Economy

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Based on the participation in international trade, economies can be divided into two types as the closed economy and the open economy. Here we introduce a closed economy (Introduction to the closed economy).

An economy that does not participate in international trade is known as a closed economy. Thus, a closed economy refers to an economy that does not keep any economic relationship with other countries. It does not have any access to imports and exports and provides all types of goods and services to its consumer itself within the nation. This type of economy is also known as a self-dependent economy, protects its industries, and thus known as the protectionist economy. Example of such economies includes Japan between the 1600s and 1850s, Spain in 1940s and 1950s, Albania in the late 1970s to mid-1980s and currently North Korea. Closed economies do not perform the following activities.

  • Import and export of the goods and services
  • Exchange of loans and gifts with other countries
  • Sale and purchase of financial securities of foreign companies like shares, debentures, bonds, etc.
  • Exchange of workers with other countries
  • Exchange of investment with other nations

N. G. Mankiw thus defines a closed economy as an economy that does not interact with other economies of the world.

The gross domestic product (GDP) in the closed economy can be measured under the expenditure method by adding consumption expenditure made by the household sector (C), investment expenditure made by the business sector (I), and expenditure of government on goods and services (G). So, GDP=C+I+G

Since a closed economy does not have any transactions with other countries, there are no differences between GDP and GNP. The closed economy is a fantasy concept. No economy can sustain itself without economic interaction with other countries in modern times. A nation needs to export its specialized output and also needs to import deficit products. Thus, in the real world, all the nations are depending upon other nations on various aspects. A closed economy is thus a hypothetical concept.

Features of Closed Economy

Features of Closed Economy
There is the absence of any kind of relationship with the rest of the world
Closed economy neither imports nor exports to other countries
They neither borrow nor take foreign aid nor lend or give aid to other countries.
The citizens of the closed economy are not allowed to go and work in the other countries
The value of GDP and GNP is identical in the case of the closed economy
A closed economy is assumed to be a self-sufficient economy
In modern times this economy may not be a realistic concept
Features of Closed Economy/Introduction to closed economy

Advantages and Disadvantages of Closed Economy

AdvantagesDisadvantages
It protects domestic enterprises from foreign competitive enterprises.These economies are probable to be less developed if they lack crucial inputs.
There is no fear of coercion from foreign countriesLess competitive as compared to open economy
This economy is easier to regulateThey lack different advantages of free trade and international access
It is assumed to be self-sufficient so it does not have to think about the global economy.  A closed economy is highly dependent on agriculture and the agricultural output may be uncertain if there are no favorable circumstances. That further reduces the competitiveness of the economy.
Advantages and Disadvantages of Closed Economy/Introduction to closed economy

Types of Closed Economy

There are two types of a closed economy as the two-sector economy and a three-sector economy.

Two-sector Economy

It is a closed economy consisting of two sectors household sector and the business sector. There is the absence of government and the rest of the world sector participation in the economic undertakings. This economy does not exist in the real world so it is a hypothetical concept. The GDP is the summation of consumption expenditure by the household sector and investment expenditure made by the business sector in the two-sector economy.

Three-sector Economy

The economy that consists of three sectors household, business, and government sector is known as the three-sector economy. There is the absence of foreign trade in the three-sector closed economy. This is also the hypothetical economy in modern times. Summation of consumption expenditure, investment expenditure, and government expenditure is GDP in this case.

Conclusion

The article introduction to the closed economy deals with a closed economy. It is an isolated economy from the world and is assumed not to take any part in foreign trade so there are no imports or exports and movement of capital and labor with the rest of the world. Hence, it is an economy that has no contact with the rest of the world by the means of trade and movement of capital and labor. It is a hypothetical concept in modern times. However, the assumption of the closed economy is needed to examine an economic model of aggregate expenditure.   

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