AN OPEN ECONOMY

A. Definition
Economics concept where economic activities between the domestic community and outside
were existed. Both individuals and businesses are able to trade in goods and services
internationally, and investments can be conducted through funds. Forms of trade are
managerial exchange, technology transfers and any other forms of goods and services. It is
totally different with closed economy in which international trade and finance do not take
place.

The trade can be conducted in two ways, export and import. Exporting is the act of selling
goods or services to foreign country and Importing is the act of buying goods and services
from a foreign country.

There are many economic advantages for society in a country if an open economy concept is
used. The main advantage is that the citizen consumers will have plenty variety of goods and
services to choose. Moreover, consumers will have an opportunity to invest their savings
outside the country for some reasons. Countries that using an open economy need not equal
output of goods and services in any given year. They can spend more money than it produces
by foreign funds. It can also works oppositely by lend the money to forigners. As of 2014,
there is no totally-closed economy that existed.

B. Capital Flows

Capital flows refer to the movement of money for the purpose of investment, trade or
business production, including the flow of capital within corporations in the form of
investment capital, capital spending on operations and research and development (R&D). On
a larger scale, a government directs capital flows from tax receipts into programs and
operations and through trade with other nations and currencies. Individual investors direct
savings and investment capital into securities, such as stocks, bonds and mutual funds.

1. The international flows of goods

In an open economy, spending need no equal output and investment.
Preliminaries :
C = Cd + Cf d
I = Id + If = spending on domestic goods
d f
G=G +G f
= spending on foreign goods
EX = exports
(foreign spending on domestic goods )
IM = imports = Cf + I f + Gf
(spending on foreign goods)
NX = net exports (a.k.a. the trade balance)
(EX IM)
 GDP (Gross Domestic Product)

Gross domestic product (GDP) is the monetary value of all the finished goods
and services produced within a country's borders in a specific time period.
Though GDP is usually calculated on an annual basis, it can be calculated on
a quarterly basis as well (in the United States, for example, the government
releases an annualized GDP estimate for each quarter and also for an entire year).

GPD identitiy in open economy :

Trade surpluses and deficits

Trade surplus happens if output is bigger than spending and exports also bigger
than import. For this trend, we can use NX as the size of trade surplus. On the
other hand, trade deficit occurs because spending is bigger than output and so
does the imports for the exports. For this, we can use NX as the size of trade
deficits.
 2. The international flows of capital
This is the financial side of international trade.

Net capital outflow

= SI
= net outflow of loanable funds
= net purchases of forefign assets

When S > I, country is a net lender

When S < I, country is a net borrower

The link between trade and capital flows can be described as below:
(Trade Balance = Net Capital Outflow)

Thus, a country with a trade deficit

( NX < 0 ) is a net borrower.