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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Deriving the Aggregate Expenditures Model

AE Model: Private Open Economy


Private Open Economy

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So now let's look at our aggregate expenditures model in a private open economy. So guess what? Just like the private closed economy, we're just gonna be taking out variables here. So aggregate expenditures model? Well this is describes the relationship between spending and production. Okay, so a private open economy is an economy that has no government but if it's open it does trade. So the only thing this one's missing is government, there is trade, there is investment, there is consumption. It's a country that has that does not have government, right? But it does have trade in this case. So a private closed economy that closed in the open has to do with the trade and a private versus let's say a public economy would have a a government. Okay, so there's no government here. So we still have our same aggregate expenditures model where we have spending as our aggregate expenditures and production as our GDP. Right? So we've got our consumption just like we've been defining as that constant amount of a regardless of G. D. P. And then we're gonna have MPC times Y okay so here we do have investment and we do have net exports but we don't have government purchases, right? There's no government in this private open economy. So there's no government purchases. So these investment And that exports can be affected by the multiplier if they change there's going to be a multiplier effect on GDP, we'll discuss that more in future videos. I swear we're gonna get to it soon. But let's go ahead and see this graph for the private open economy, guess what? Look what we've got again, we've got our 45° line. And how do you think we're gonna be finding our macroeconomic equilibrium? It's gonna be along the 45 degree line. Nothing much is gonna change here. It's just the type of economy that we have now. What I would suggest is getting real familiar with the full equation, right? The C plus I plus G plus N. X. And they just simplify it in these economies, right? These are just simpler versions of it. So what we have here again is we're gonna have our consumption function and then we're gonna add investment and add net exports to it. So consumption just like we've been defining, right, there's gonna be this to when there's no GDP at all. We've got to and as we add G. D. P. It's gonna go up at this rate of half of that. So if we add to GDP it's gonna add one more to our consumption and again one more to our consumption and it's going to be going up at that rate. So this is our consumption function right here, right? We're just graphing the line two plus 0.5 Y. And that's our consumption right there. So let's go ahead and add investment to it. Which is going to be two plus the one gets us to three plus 0.5 Y right? Two plus one plus the 0.5 Y. That is our investment. Our consumption plus investment And that would be a line like this. Right now our intercept here is at three and it goes up at the same rate. The slope is the same as we add two. We're gonna add as two more GDP there's gonna be one more consumption right? Because of that MPC of half. So again we've got a line just like this so that's our C. Plus. I remember when we talked about the private closed economy this was our aggregate expenditures but not in this case. Right Because we do have net exports were trading with other countries. There's just no government in this private closed private open economy. Alright so C. Plus I. Plus N. X. Well this is gonna be our aggregate expenditures here. Right this is aggregate expenditures because there's no government purchases but this is all the other purchases that there are. So two plus one plus 0.5 gives us 3.5 for our our intercept plus 0.5. Y. Right so it's gonna go up at that rate of 0.5 Y. So we'll have this right here 3.5 right there in the middle and it's gonna go up at that same rate. So there we go. This is going to be our aggregate expenditures line in the private open economy. Okay so it's gonna look something like that. And this is going to be aggregate expenditures equals C. Plus I Plus N. X. Okay so notice no government purchases in this economy. That's it C. Plus I. Plus N. X. And we can find our macroeconomic equilibrium just like before on that 45 degree line. And that's gonna be right here approximately where aggregate expenditures equal seven and our G. D. P. Equals seven. So by producing $7 billion worth of goods say there would be $7 billion worth of of spending and we would be in equilibrium. So again the theme here is that our equilibrium is where the aggregate expenditures line crosses the 45 degree line. Cool. And that'll tell us where our GDP and aggregate expenditures are equal and that's about it. Nothing too crazy here with the private open economy. Let's go ahead and move on.