In an open economy, there is interaction with other economies in terms of both trading of...

In an open economy, there is interaction with other economies in terms of both trading of goods and services and borrowing and lending.

Select one:

True

False

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Expert Solution

The given statement is TRUE.

The reason for this can be understood by knowing what happens in an open economy based on the model of International trade balances. The model starts with the basic income identity of Y = C+I+G+NX.

We can re write this as Y-C-G = I+NX

The lhs is the national savings, so we have S= I+NX

or, S-I = NX

So in an open economy the countries trade both goods and services (goods e.g - oil, service e.g - financial services). The amount of trade depends on the savings-investment gap. The larger the gap, the more is the net exports of both goods and services. This also implies that when a nation saves more than invests then it has positive net exports and then due to the positive savings it has it is able to lend money to foreign nations. While if S is less than I then it has trade deficit and is a borrower. So open economy involves trade of good and services and borrowing and lending.

Rahul Sunny answered 1 year ago

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