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What is a Closed Economy?

A closed economy is an economic setup where a nation doesn’t take part in the import or export of goods or services to/from other countries.

For example, Ukraine, after the war with Russia, is on the verge of destruction and can be said to have a closed economy. Their economy is predicted to get down to 45.1% in 2023. Thus, every economic activity, including imports and exports, is closed due to mass destruction.

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Key Highlights

It defines the state of functioning where a country refrains from trading internationally.

One feature is that production and consumption occur within the boundary of the said region.

In today’s world, no country accurately abides by this concept. However, there are a few countries that function in a somewhat similar fashion, like Brazil, Morocco, and Ukraine.

How Does it Work?

In a closed economy, as there is no scope for international trading, all the products consumed are produced within the country. The above model shows how it operates. The cycle of production and consumption follows one another. There are four areas within this economy where the activity of trading occurs.

As seen in the image above, businesses approach financial institutions to receive financial aid for investment purposes. With this help, they can manufacture products and bring services to the market for the mass to utilize.

After manufacturing, the products are sent to marketplaces and sold to consumers in exchange for a certain monetary amount. So consumers can collect their needful products and services from the market by spending a certain amount of their money.

After carefully considering their expenses, most people then opt to save up a certain amount for future purposes that they can deposit in a bank or any such financial institution.

Real-World Examples Example #1

In recent times, Sudan has been the closest country to abide by the terms of a closed economy. However, it has not shut down trading entirely but has shown minimum engagement lately.

Example #2

Brazil is an economy that has the fewest goods imports when compared to other nations as measured as a percentage of GDP. As a result, the economy is nearer to being closed, with trade flows—exports plus imports—averaging just 25% of its GDP.

Few Brazilian companies export and less than 0.5% of all formal-sector companies are exporters. In fact, there are fewer than 20,000 exporters in Brazil overall. Brazilian businesses must contend with several competitive obstacles, such as real appreciation and protective trade regulations.

Features

In a closed economy, any import or export activity does not occur.

It never buys or sells any bonds, debentures, shares, or financial instruments from or to foreign countries.

There is no activity of borrowing or lending from other countries.

In this economy, exchanging gifts with foreign countries is impossible.

The residents of such an economy cannot work in another country; no foreigners are allowed to work within the domestic territory of such an economy.

Hence, the economy’s Gross Domestic Product and Gross National Product are the same for the above-stated features.

Reasons #1 Physical Isolation

Suppose a country is physically isolated, like an island or a land area entirely encompassed by mountains.

In that case, these natural elements will lead such an economy toward a closed one.

#2 Transportation Cost

Given that a region is entirely excluded from commercial planes, it can be assumed that the cost of transportation for goods will be high.

This can lead to a country choosing to function in a closed economy as the high transit price will result in a high-cost price of the goods, which is not entirely logical, and for some countries and their people, it might not be affordable.

#3 Government Decree

Another reason for a country to opt to function as a closed economy will be if the government in power shuts down borders to regulate taxes.

In such a situation, any form of trading with other countries might result in a violation of law which might lead to punishment.

The government strongly supports its producers in generating revenue and taxes for international players.

#4 Cultural Preferences

Another prominent reason for choosing to function as a closed economy is when the people of that particular region refuse to contact or trade with people from a different culture.

Advantages

One of the highlights is that it safeguards against the ups and downs of the global trade market. It lacks domestic resources and financial capital as it has no connection with other countries.

As the entire economy depends on its goods and services, global trade and investment are not dependent on it. Domestic production is the only option to meet the demands, so the variants in terms of product choices are pretty low.

It is not vulnerable to global shutdown. The facilities of having the option to trade internationally and freely are absent.

The government can exclude specific industries from certain quotas, tariffs, and subsidies to prevent any scope of international competition. As it is known to be self-sufficient, it automatically gets excluded from international diplomacy.

Final Thoughts Frequently Asked Questions (FAQs) Q1. What are the different kinds of closed economies? Q2. What is the formula for calculating income in a closed economy?

Answer: The formula for calculating income in a closed economy is Y = C + I + G. Here, Y is National income, C is Total consumption, I is Total investment, and G is Total government expenditure.

Q3. Are there any countries that follow the concept of a closed economy?

Answer: No, as of now, no countries adhere to the theoretical aspects of a closed economy. However, Brazil functions similarly to it as it has a very low import and export ratio.

Q4. What is a closed and open economy?

Answer: A closed economy is one in which there are no capital flows, no imports or exports, and no interaction with other economies. Contrarily, an open economy is one that engages in unregulated international trade.

Q5. What is better: an open or closed economy?

Answer: A company’s salary and working environment are typically better in a trading company than in a company that does not trade. Economies with relatively open markets grow more quickly than relatively restricted ones. Furthermore, the citizen-consumers have access to a wider range of goods and services. The buyers also have the option of investing their money abroad.