Posted: February 1st, 2023

Circular Flow of Income in an Open Economy

This flow or cycle repeats itself continuously as the traders i.e., exporters and importers repeatedly indulge in purchasing and supplying the products or services etc., to various countries respectively.

In simple terms, the circular flow of income in an open economy adds 2 new dimensions:

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Firstly, payments for exports and the receipt of payments for imports to and by the country respectively.

Secondly, the labour aspect of the equation. The foreign sector/foreign countries receive manpower from countries and make payment for their services to them.

Advantages and Disadvantages of Open Economy
The advantages are as follows –

Countries experience faster economic development and growth due to easy access to new and more efficient technologies.

There is a flow of investments into the country making it easier to undertake large projects.

Open economies promote research activities leading to inventions and innovations.

Rise in employment opportunities.

The disadvantages are as follows –

With open trade and international business comes the exposure to some unavoidable risks more like a knock-on effect. A country from which key resources are being imported or to which key resources are being exported experiencing a recession would have a knock-on effect on the country which is buying from or exporting to that country.

There is outflow of funds to the countries from which resources are being imported and if the value of exports is not greater than or at least equal to the value of imports, the country has a trade deficit that needs to be funded.

The dependence on imports impairs the ability of local manufacturers to produce those goods locally.

The amount of competition faced by the local producers increases which may even lead to many shutting down their businesses due to their inability to match the pricing or the innovation that may come from the importing country.

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