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Sem 5 Prep
← Open Economy MacroWhat an open economy is

Formulas for this chapter

Aggregate demand in an open economy

AD = C + I + G + (X - M)

Any question that asks for the level of demand or the contribution of the foreign sector. Compute net exports separately, with its sign, before adding.

C
Consumption expenditure by households
I
Planned investment expenditure
G
Government expenditure on goods and services
X - M
Net exports: exports minus imports, an injection when positive and a leakage when negative

Openness ratio

Openness % = (X + M) / AD x 100

Measuring how exposed an economy is to the rest of the world. Note that this is a gross measure: it adds exports and imports, while the trade balance subtracts them.

X + M
Gross trade: exports plus imports, both counted positively
AD
Aggregate demand, computed first from the identity above

Percentage change in the exchange rate

% change in R = (R(new) - R(old)) / R(old) x 100

Whenever a question moves the rate and asks by how much the currency has depreciated or appreciated. R is domestic currency per unit of foreign currency, so a rise in R is a depreciation of the domestic currency.

R
Units of domestic currency per unit of foreign currency, for example Rs per US dollar
R(old)
The starting rate, and always the denominator
Step 3 of 23
The real wordsTheory

Open versus closed, on four bases

The student note tabulates the contrast. A four-row table is exactly what a five-mark "distinguish between" question wants.

BasisOpenClosed
DefinitionTrades goods, services and financial assetsNo trade, no capital flows
PolicyNeeds trade, exchange rate and capital policySimpler policy set
InteractionGlobal marketsDomestic markets only
StabilityExposed to global shocks, gains global opportunityInsulated, but no opportunity

A closed economy is a teaching device, useful for models and unrealistic in practice.

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