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The difference between an open economy and a closed economy
The difference between an open economy and a closed economy

There are two main models of economic development that can be chosen by different countries. The models are called an open economy and a closed economy. These two approaches are completely contrary in terms of the directions of economic development; however, each of them is currently used by certain countries. Thus, the main aim of this paper is to research the advantages and disadvantages of the open economy and closed economy, examine the difference between the approaches, and provide some examples of countries that use either of the economic models.

The Main Features of an Open Economy

The economic system that is described as an open economy is one of the most popular models of a country’s development nowadays. The main features of an open economy are connected to free trade and other kinds of economic interactions with the economies of other countries. An open economy approach actively involves countries into international economic relations by exporting and importing goods, services, encouraging free flows of capitals, and workforce. An open economy is market-oriented; it applies free market policies. The prices for products and production levels are determined by market forces in the economic model. Moreover, industries in an open economy are mainly owned by separate individuals, not the government. In the international trade, a policy of free trade is the main direction of the open economy.

However, an absolutely open economy is a theoretical concept rather that the reality. Countries cannot apply the model in its pure form because it is impossible and economically unreasonable. Countries cannot open their markets completely to other countries because it would lead to the collapse of the economy and unregulated economic relations in the market. Thus, it is common for countries to apply the open economy approach in combination with some minor governmental regulations like fiscal and monetary policies. Moreover, even the most open economies of the world might still have some industries that are owned by the government or monopolised. Thus, the main feature that allows identifying whether an economy is open is the existence of internal policies that allow market forces to define pricing and production.

The Main Features of a Closed Economy

A closed economy is another approach to developing the economy of a country; it is also called a regulated or managed economy. This economic model is mainly based on restricting the trade and economic relationship with other economies. It is aimed at closing the economy from the rest of the world and separating it from the global economy. A country that applies the closed economy approach stops participating in global economic processes in order to become absolutely independent and self-sustainable. Protectionism and opposed barriers in the international trade are the main trends of the closed economy. The prices in the closed economy are strictly controlled by the government, not by the market. Furthermore, governments impose protective tariffs, extensive regulations and policies in the market. The government has a leading role in controlling the production of goods and services in every sector of the national economy, especially in nationalized or state-run industries.

The Difference between an Open Economy and a Closed Economy

Therefore, the main differences between the open economy and the closed economy are based on the way their economic systems develop regarding the international trade and international economic relationships. The open economy is aimed at opening the borders to economic interactions with other countries and actively participating in the global economic processes. On the contrary, a country with the closed economy tends to close its economic borders to other countries, separates itself from the international economy, and does not tend to get involved in global processes.

An important feature is the level of governmental intervention in the economic processes and the market development. In the open economy, the impact of the government is minimal; the market forces regulate the prices and production levels supporting the balance between the demand and supply. Meanwhile, the closed economy is heavily regulated by the governmental mechanism; the market is dependent on the policies and restrictions implemented by the government. Moreover, the industries ownership also varies between the models. Industries in the open economy are mainly privately owned . In the closed economy, they are predominantly owned by the government .

The open economy is more often considered as a system with more advantages for the countries that apply it. The open economy is more stable, flexible, and adjustable than the closed economy. Thus, it has an advantage over the closed economic system, although, some countries such as North Korea, still use the closed economic model. To summarize, the open economy is more market-oriented; therefore, it is more efficient and profitable for the businesses.

Advantages of a Country Having an Open Economy

The fact that most countries in the modern world follow the open economic approach can be explained with a large number of advantages of this economic system. The main advantage of a country having the open economy for consumers is the availability of a wide variety of products in the internal market. Furthermore, high flexibility of the open economy allows attracting larger amounts of direct foreign investment. Another advantage is that the open economy is more capable of being adjusted to the changes of the global economy.

The open economy and free trade of goods and services benefits countries’ economies. First of all, following this economic model enables a country to increase production by specialising in the spheres where it has a comparative advantage. The specialisation helps to increase proficiency and productivity taking advantage of the economy of scale and decreased average costs. Likewise, countries with economies benefit from higher efficiency of resource allocation and increased domestic output.

High competition in the market is one of the consequences of the open economy. Competition puts additional pressure on companies that are present in the market, although, it has also got a positive impact. Hence, tough competition in the national markets promotes greater usage of innovative production methods, new technologies, methods of marketing and distribution. Furthermore, high competition results in decreased prices for goods and services; it is an absolute advantage for the consumers.

The system of the open economy has positive consequences not only for governments and national markets, but also for the employment market. Due to trade liberalization, the level of employment in exporting industries goes up. Product specialization results in creating new work places in the countries.

To conclude, the overall effect of having the open economy is rather beneficial for any country. Increased efficiency, high production levels, competitive industries, increased living standards, high levels of economic growth and development, and rising real incomes are the result of free trade policy.

Disadvantages of a Country Having an Open Economy

Despite having numerous advantages, the open economy has some aspects that have a negative influence on the economies. Hence, the main disadvantage of the open economy is connected to a high risk of the development of structural unemployment due to removing trade barriers. This factor has an impact on people’s welfare and economic health of the country.

The countries that apply the open economy approach have issues with rising economic instability in the national markets. It is related to the countries becoming dependent on the international trade and global markets. National businesses and people become more pregnable to downturns in their partners’ economies; they are often the cause of recession, export incomes falling, dropping GDP, decreased incomes, and higher unemployment.

Highly competitive business environment, which is a precondition of the open economy, brings some difficulties to new or developing industries. Large transnational corporations and lack of protection policies form the governments make it uneasy for new companies to enter the market and succeed in it.

Moreover, opposing trade liberalization leads to environmental pollution. The companies tend to cut down their costs to succeed in competing with companies from the countries that have weaker environmental legislative base.

Therefore, the main differences between the open economy and the closed economy are connected to having opposing international trade policies and different approaches to the governmental regulations of national markets. Thus, the open economy can be described by encouraging free trade, regulating the market by market forces, and the lack of governmental intervention in the economic processes. The closed economy is based on setting up the barriers for foreign companies to enter the national market and closing up the economy.

The experiences of many countries have proven a prerogative of the open economy over the closed economy. The main benefits of the open economy include having a wide choice of products and services by lower prices in the country, increased technological breakthrough, adjustability and flexibility of the economy, increase in production, and levelling up the employment market. However, the open economy has some disadvantages such as high risks of increasing unemployment, economic instability, and environmental issues.

The essay was written and published by the professional writer from plagiarismsearch service - Milly Jones.

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