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Deriving the Aggregate Expenditures Model

AE Model: Private Closed Economy


Private Closed Economy

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So let's talk about a simplified version of the aggregate expenditures model. In a private closed economy, let's see what that means. So remember aggregate expenditures model, we're linking up the relationship between spending and what's the other side production, Right? Production. So spending and production. Well, a private closed economy, this is when we say a private economy means no government and a closed economy means no trade. Okay, so it's a country that does not have government or international trade. So we're still gonna use the same model of aggregate expenditures equals G. D. P. At the equilibrium. So aggregate expenditures being our spending and GDP being our production. Well this is actually just easier because in this economy there's no government purchases and no net exports. So all of this is gone, there's no there's no government purchases, no net exports. All we have is consumption and investment, right? That's all of our all of our spending in the economy either comes from consumption from our consumers or investment from firms, basically. Right? So we're gonna have very similar to what we what we've been doing, we have our consumption function that's gonna have some uh base amount of consumption, regardless of income, there's gotta be some consumption uh to survive, right? There's gonna be food shelter, things like that. And then as we make more money MPC, right? Times, Y D so just like we've discussed with our consumption function and investment, what we're gonna keep that constant still. It's always gonna be constant in these in these in these topics here. Alright. So remember that this can be affected by the multiplier effect, which we will discuss in further videos, let's go ahead and see how this simplified model of the aggregate expenditures where there's no government, no net exports, how this looks like on the graph. So just like before we're going to be looking for our macroeconomic equilibrium, just in this case, well, there are no government purchases and there are no net exports. So all we have is consumption and investment. So if we look at this graph, we're gonna have our consumption function. Let's go ahead and graph our consumption function, which it starts here at this point too. Right? If there's no G D. P, so this is gonna be aggregate expenditures, this is G. D. P. Which is why those are axes here. So if there's no GDP if there's no production in the economy, well, there's still got to be some consumption for people to survive and this base amount of two. So when there's no production here at zero production, we're gonna have to consumption. Right, two billion consumption will say, and this will go up at a rate of 0.5. So the marginal propensity to consume being 0.5 times why? So, for every two uh GDP, right, for every time we go up by two G. D. P. Well, that goes up by one on the consumption function, right? Because half of it goes to consumption, So to G D. P G. D. P. Was to hear, well this would be 10.5 times two. So this would go up like this, right? Just like we saw on the other graph groups like this here's three right here because it's two plus one plus one again and we end up with a line like this, right? So very similar to when we had our full economy with government with everything right? We've still got our consumption. But the only thing we're gonna add to it in this case is investment. Right? Because this is a private closed economy, we're gonna end up with three plus 0.5 Y. Right? The two plus the one consumption plus investment. And then we add that uh the income part there the marginal propensity to consume times the income. So all this does is it shifts us up to three. Right, shift this graph up from 2-3 but the slope stays the same. So it's gonna be a parallel line to that. And this is it we're done in the private closed economy. This is all that, all of the spending that we have is either from consumption or investment. So this is c right here consumption and this is our aggregate expenditures of C. Plus I right because there's no government purchases, no net exports, that's our total aggregate expenditures. C plus I so here we go. We're ready to find our our macroeconomic equilibrium. Do you remember where that's gonna be, yep it's right there where our consumption, where our aggregate expenditures line, consumption plus investment touches the 45 degree line. Right, just right here, consumption plus investment equals six in this case. So where are aggregate expenditures equal? Six? Our production equals six. This is our macroeconomic equilibrium in this case. All right. It's simple as that. Just as what we learned in the previous example, except we took out some variables. So we have is consumption plus investment. So right here about bologna macroeconomic equilibrium occurs where the E line crosses the 45 degree line. Okay, pretty much just what we just learned. Except we took out some variables for government. Net exports. Cool. Let's go ahead and move on to the next video.