Closed economy
Topic: Balance of Payments and Exchange Rates · NCERT: Class 12, Ch 6 "Open Economy Macroeconomics"
Meaning
A closed economy has no links with the rest of the world. It does not trade goods, services or financial assets with other countries. Textbooks use it to keep the first models simple, where output is decided only by C + I + G. Real modern economies are almost all open, so the closed economy is a teaching device, not a description of any actual country.
Example
Take a marginal propensity to consume (c) of 0.8. In a closed economy the multiplier is 1/(1 − 0.8) = 5, so a ₹100 rise in spending raises output by ₹500. Now open the economy with a marginal propensity to import (m) of 0.3. The multiplier falls to 1/(1 − 0.8 + 0.3) = 2, so output rises by only ₹200, because part of each round of spending leaks out as imports.
Don't confuse with
- Open economy: an open economy trades goods, services and usually financial assets with other nations. Its income identity includes net exports: Y = C + I + G + X − M.
Related concepts
- Open economy
- External sector
- Export
- Import
- Demand for domestic goods
- Net exports
- Marginal propensity to import
- Autonomous imports