An open economy is one that interacts freely with other economies around the world. An open economy interacts with other countries in two ways. It buys and sells goods and services in world product markets. It buys and sells capital assets in world financial markets.
An open economy is one which deals with other countries through distinct methods. Till now, we had not contemplated this feature and just restricted to a closed economy in which there are no connections with the rest of the world to ease our analysis and elucidate the basic macroeconomic systems. Most of the modern economies are open. There are three ways in which these connections are entrenched.
Output Market: An economy can deal and trade in commodities and services with other nations. It broadens the preferences in the sense that the customers and manufacturers can pick between domestic and foreign commodities.
Financial Market: Often, an economy can purchase financial assets from other nations. It furnishes investors the opportunity to pick between domestic and foreign assets.
Labour Market: Enterprises can pick where to locate manufacturing plant and workers to pick where to work. There are several immigration laws which constraint the movement of labour between nations.