A closed economy is one that does not make any exchange with other countries. That is, it is an economy that does not interact with the rest of the world and only consumes what it produces internally.
In a closed economy, neither imports nor exports are made . Everything that is consumed must be produced internally. There are also no foreign investments or international companies since they cannot coordinate their activities with other companies outside the country.
Implications of the closed economy
In a closed economy, external flows are zero, so the following identities are met:
- Gross Domestic Product= Private Consumption + Internal Investment + Public Expenditure
- National investment = National savings = Private savings + Budget surplus
The first identity indicates that what is consumed by both private agents and the government, together with the resources allocated to the investment, come from internal production.
The second identity tells us that the investment must necessarily be financed with internal resources (private and / or public).
Advantages of the closed economy
There are very few advantages of this model, only artificial protection for internal producers, cultural identity and heritage.
Disadvantages of the closed economy
- Little variety and availability of products or services: the inhabitants must resign themselves to consume only the products and services that are produced within the country. There is no access to the wide variety of international production that exists in the world that could perfectly complement or improve the local supply.
- Little competitive pressure: in the absence of competition from external companies, domestic producers can become inefficient, abuse their dominance and create monopolies that harm the consumer.
- Investment limitation: by not being able to access external resources, the investment is limited which reduces the capacity for growth.
- Under access to new technologies and ideas: by not exchanging abroad, the opportunity to access better technologies and new ideas that drive the country’s growth is lost.