Introduction to Open Economy

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Meaning/Introduction to Open Economy

An economy in which there is the provision of international trade or foreign trade is known as an open economy. It means the economy that has a freedom of socio-economic relationship with the rest of the world is an open economy. Domestic people and businesses can trade in goods and services with international people and businesses. Domestic products and funds can flow across the world. This economy is a market economy with the least intervention from the government. The policies of these economies are liberal and open and as a result goods and services of different countries compete with each other.

There are four sectors in an open economy the household sector, the business sector, the government sector, and the rest of the world sector or foreign sector. This economy thus facilitates global trade that can make all the trading partners better off. In the real world, almost all countries are open in the sense that they are integrated into the world economy with varying degrees of openness. In an open economy, the GDP is calculated as GDP= C+I+G+(X-M)

Here C stands for household consumption expenditure, I stand for investment expenditure of the business sector, G stands for government expenditure and X-M is net export obtained by subtracting the number of imports from exports. 

In the words of G.N. Mankiw, an open economy is an economy that interacts freely with other economies around the world. Thus, in the open economy, there is free movement of human resources, and the human resource can perform their task following skill, knowledge, and efficiency in any country. The open economy can perform the following tasks.

  • Sale and purchase of goods and services with the rest of the world
  • Transaction of financial instruments
  • Lending and borrowing of public and private debts
  • Placement of human resources across the country as per their interest
  • Free flow of remittance

Features of Open Economy

The open economy has international relationships with the rest of the world in socio-economic aspects
It imports and exports goods and services from and in the world market.
An open economy can take and provide foreign aid and grants from and to other economies. 
The citizens of the open economy move to other countries
It sends gifts and remittances to foreigners and receives the same from them
It is a realistic concept and almost all countries have some sort of foreign relation
GDP and GNP may differ in an open economy due to the presence of NFIA
Introduction to open economy/Features of Open Economy

Advantages and Disadvantages of Open Economy

There are larger facilities of choice available to consumers as they god goods and services available from the global marketAn open economy increases the dependency of one economy on others
It increases the opportunity for foreign direct investmentIt always creates threats to domestic industries
It contributes to economic growth to a greater degreeThe open economy may increase the indebtedness of the country
It increases competition and increased competition helps to reduce the priceOpen economic relation between nations is prone to trade cycle and that can threaten to entire world’s economic environment
It helps to develop skills and efficiencies in the labor force.It may cause brain drain problems in developing economies.
Introduction to Open Economy/Advantages and disadvantages


An economy that participates in international or external trade relations is called an open economy. It consists of four-sector of the economy the household sector, the business sector, the government sector, and the rest of the world sector. An open economy keeps multiple short of relations with other countries. In today’s world, every economy has a certain degree of relation with the rest of the countries.

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