Open economy

An open economy is an economy in which people, including businesses, can trade in goods and services with other people and businesses in the international community at large. This contrasts with a closed economy in which international trade 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. Together exporting and importing are collectively called international trade.

There are a number of advantages for citizens of a country with an open economy. One primary advantage is that the citizen consumers have a much larger variety of goods and services from which to choose from. As well consumers have an opportunity to invest their savings outside of the country.

In an open economy, a country's spending in any given year need not to 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.

Economic models of an open economy

The basic model

The basic economic model of an open economy is the same as that of a closed economy model except two new terms are added: Exports $(EX)$ and imports $(IM)$ :

Y = C^d + I^d + G^d + EX

Y = C + D + G + (EX-IM)

With Y being gross domestic product / national income, $C^d$ is consumer consumption of domestic goods and services, $I^d$ is investment in domestic goods and services, $G^d$ is government expenditures on domestic goods and services. The term $(EX - IM)$ is usually called net exports and is sometimes designated with the term NX.