Explain the difference between an open economy and a closed economy - Essay Example

However, opponents believe that more openness leads to loss of jobs, dumping, interdependence among nations, and economic sanctions among others.2 A closed economy on the other hand, is accused of hindering technology transfer and foreign investments although it is appropriate in ensuring protection of local industries. The paper will discuss the numerous differences between a closed and open economy as well as the advantages and disadvantages a country would have by using either of the economic models.

Differences between Closed and Open Economies There are numerous distinctions between a closed and open economy. A closed economy is one in which trade is carried out within the borders of a nation or domestically hence the gross domestic product (GDP) is the same as gross national product (GNP). An open economy on the other hand, is one in which trade is carried out within and outside the borders hence the GDP and GNP are not equal but depend on volume of imports and exports.3 An open economy is achieved by eliminating the barriers to trade such as tariffs and import quotas.

However, most open economies have put some trade barriers so as to protect crucial industries from competition in the world market or to protect consumers against harmful products and also to protect the environment from pollution.4 It can be noted therefore that there is no perfectly closed or perfectly open economy as each has an element of closeness and openness. A closed economy does not allow movement of labour across borders unlike open economy where workers are free to work anywhere in the world.

Another distinction is that a closed economy does not allow movement of capital across borders hence investments are domestic in nature and foreign exchange rates do not impact on the economy unlike in an open economy where there is movement of capital across borders. Businessmen can therefore invest in foreign stocks and money markets thus the economy is affected by exchange rates.5 According to Jane, sometimes open economies can act as closed economies.6 This is especially so if few members with open economies act as a tightly integrated economic bloc and only trade with each other thus becoming a collectively closed economy.

On the other hand, a country cannot produce all the goods and services it requires hence it is forced to import some products. Open economies are characterized with large multinational corporations like starbucks with braches all over the world and this is not the case in closed economies. Advantages and Disadvantages of Closed Economy A closed economy does not have any dealings in the global market therefore is not affected by factors outside the country. For example, the global financial crisis that started in the US spread to all parts of the world due to interrelatedness of product and financial markets.

The developed countries are known to impose economic sanctions on developing countries as a condition for giving them funds for development. These sanctions impact negatively on the economy but a closed economy cannot be under such sanctions since it is self reliant.7 Another advantage is the effectiveness of fiscal and monetary policy in the economy. An expansionary fiscal policy is meant to stimulate the economy during recession by raising aggregate demand. This is