Saturday, June 9, 2012

Open And Closed Systems In Macroeconomics

A Closed system is a structure whereby boundaries that should not be exceeded are clearly defined. If there are any variables present within the system, they are also identified and defined (Hein & Stockhammer, 2011; Hein & Truger, 2007). To a certain extent the values of the variables should also be known. According to Hein and Stockhammer (2011), a closed system can also be referred to as an open model because all the exogenous variables are clearly defined and are known. Therefore, there is no change of environment in which the variables are operating in. According to classical economics, the main goal of any organisation is to attain economic efficiency (Hein &Truger, 2007). They conclude that initially, organisations operated within closed systems.

Thus, they were rational entities of economics. There are two characteristics that emerge when considering closed system economics. Closed systems are entirely deterministic and can be predicted (Hein & Stockhammer, 2011). It is easy to predict the outcomes in a closed system since the initial circumstances and incentives are well known. Classical economists developed the closed economic system (Hein & Truger, 2007). The main aim of coming up with the closed system was to eliminate the effects of the external environment in economic operations. Closed systems tend to follow bureaucratic stages set to carry out various activities (Gwartney, Stroup, Sobel & MacPherson, 2010).

In a closed system, the new Keynesian and new classical theories are placed within clearly identified boundaries of economics. The monetarist Keynesian arguments are classified as ideological and thus falling outside the economic realm . According to this model, an organisation should factor in the effects of the environment when managing its business . On the other hand, an open system is where there are no defined boundaries within the system, and any variables present are not defined nor explained (Hein & Truger, 2007). An open system is not an exact opposite of a closed system. This is because when there is one component that is not defined in a system, the system is categorised as an open system.

An open system is grounded on the biological aspect. In this system, elements cannot be easily determined nor predicted as there are uncertainties prevailing in the external environment (Gwartney, Stroup, Sobel & MacPherson, 2010).In the concept of an organisation, external factors affecting an open system can be beyond the control of the organisation (Gwartney, Stroup, Sobel & MacPherson, 2010). These external factors may include political influence, societal effects and ecological changes among others. However, this results into a very effective organisation.

Circular Flow
Inner and Outer Flows in a Closed System Circular flow is used to show how money flows within a complex economy. In the economy, various processes are involved such as households, governments, foreign agents and businesses. In a circular flow of money, we can think on two processes; one for business and the other for households. Production factors obtained by businesses include land, capital and labour. We find that business go to the factor market while households go to the goods market (Jespersen, 2009). Households use the income received as payments (wages and salaries) for services offered to business to purchase goods and services from other businesses. Conversely, businesses use the money received from households to buy factors of production they require. Thus, money flows in a circular motion within the economy (Gwartney, Stroup, Sobel & MacPherson, 2010).

For example, when a consumer is paid for the services he offered to a business, he uses the money to purchases a book from a bookshop. The bookshop uses the money received to buy printing papers or hire labour for editing books. This circular flow of money illustrates the flow of money within a closed system economy. Thus, in a circular flow of money only domestic exchanges are considered and no involvement of foreign agents is factored.

When the government, foreign agents or saving system are not involved in the economic system, there are usually no leakages in the system such as taxes (Hein & Stockhammer, 2011). In an open system, we find that businesses and households purchase their requirements both locally and internationally. When households purchase goods from international markets, taxes that flow into the domestic economy are charged (Jespersen, 2009). On the other hand, when businesses move to foreign markets seeking factors of production, they transfer rent and wages for services to the foreign markets. For example, when a book author from United States publishes his book in China, he creates a leakage in the domestic system.

Inner and Outer Flows in a Closed System
An open system considers the flow of money both domestically and internationally between countries. The demand for imports from a foreign economy consists of goods for investment, consumption of government goods. The import depends on income level, the interest rate among other factors. As highlighted by Mundell and Fleming, in an open economy, the export demand from a foreign economy depends on the currency exchange rate and the income level (Gwartney, Stroup, Sobel & MacPherson, 2010). Additionally, the same factors affect the domestic demand for imports into a country. This is because the exchange rate of the currency determines the foreign prices of the products.

Leakages and Injections in an Open System
Leakages also occur in the open system. According to Hall & Lieberman (2009), leakages occur when money flows from domestic households and businesses to foreign markets through taxes. For example, when an American company hires an employee from China, the wages paid to the employee creates a leakage within the economic system. However, Jespersen noted that leakages developing in an open system are considered as part of domestic economic activities and inject cash into the economy . This is because they bring money into the economic system from governments and households in foreign countries.

The government goes to the factor market seeking domestic factors of production such as labour, land and capital. It also goes to the domestic goods market seeking goods such as machinery, vehicles among others . According to Hall and Lieberman (2009), exports to foreign markets bring money into a country's economic system. This is because foreign countries purchase goods produced domestically using local factors of production. For example, when the US exports hotdogs to China, revenue is generated for the US exporting firm. On the other hand, the export tax charged by the government brings money into the economic system.

Another leakage in the open economic system is through the savings of the households (Hall & Lieberman, 2009). This can either be in the bank accounts or stock markets. In turn, the money flows to the financial sector and it is credited to other businesses or households. The households use loans to purchase goods such as vehicles, seats, mortgages among others (Jespersen, 2009). Alternatively, businesses use the loans they receive to purchase factors of production such as machinery. Therefore, the flow of money to the financial sector from households under the term savings is a leakage into the economic system.

Copyright (c) 2012 Morgan D

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