An open economy is one where national economic policies allow for open trade between countries. Open economy models can define how a country engages in trade between itself and other countries. Common models for an open economy include free, fair, or imbalanced trade, depending on the conditions of the current economy. Open economy models are often most common in countries that require heavy trade in order to sustain their economies. The degree of openness depends on the open economy models a country may choose for its trade practices.
Free trade occurs when a country allows any movement of goods between itself and other countries. No tariffs or barriers exist to restrict the amount of goods entering or leaving. Open economy models that work with free trade agreements may work best in smaller countries. These countries tend to have fewer economic resources and require outside goods in order to sustain their economies. Free trade can also increase the living standards of individuals who reside in the country.
Open economy models may also engage in fair trade, which is a more equitable treatment between economies. Unlike free trade, a country will not engage in the trade of goods with all countries, instead only those that develop and treat citizens equitably. In short, fair trade attempts to help developing nations grow and expand by working with specific countries. Command or centralized economies may not be a part of fair trade agreements because these countries restrict free access to economic resources. The inequitable treatment of citizens can also restrict fair trade agreements.
Imbalanced trade in an open economy model occurs when a country imports more goods than it exports. Imbalanced trade models are not always bad so long as a country can sustain its economy through nonimport items as well. Heavily importing goods from other countries can actually decrease the cost of living for individuals in a nation. For example, when a nation is unable to produce goods at an inexpensive price, imported goods may be cheaper than those produced in the country. Therefore, an open economy makes more sense through importing cheaper goods from more efficient economies.
The dependency of a nation on imports often dictates the rules and regulations for open economy models. Many factors affect a company’s trade policy. Competition is often one of the most important factors. Multiple countries competing for the same open economy often attempt to lower prices more than the other competitors. Demand from multiple open economies can also increase trade between countries.