Final answer:
An economy is viewed as a small open economy if it cannot influence the world real interest rate. The level of trade it engages in and its trade balance are separate matters that depend on its history, geographical position, and economic policies. Size alone doesn't determine the level of trade or balance.
Step-by-step explanation:
An economy is considered a small open economy if it is too small to affect the world real interest rate. This definition is related to the economy's ability to interact with global markets without influencing major economic variables such as the global interest rate. Other considerations, such as its GDP size, the level of trade, and the trade balance, are separate issues.
For instance, a large economy can have lower levels of international trade because it can sustain a significant amount of trade internally and this aspect has minimal impact on the trade imbalance. On the other hand, imbalances between domestic physical investment and domestic saving can lead to a trade imbalance, irrespective of a country's size or the level of international trade it engages in.
Nations like Sweden, with many nearby trading partners and a history of trade, demonstrate high levels of trade despite being small. In contrast, large economies such as Brazil and India may have lower levels of trade due to different trade policies. Similarly, the United States and Japan are examples of extremely large economies with low levels of trade relative to the world standard.
The level of trade and the trade balance are distinct concepts. The level of trade involves the amount of trade relative to the size of an economy, while the trade balance represents the difference in value between exports and imports.