Aggregate Expenditure Model for Private and Closed Economy

Introduction

• Private and Closed Economy:
  • Private: No public sector (government) involvement.
  • Closed: No international trade (no exports or imports).

Key Features

1. No Government Spending:
   • Government expenditure (G) is zero.
   • No taxes as there’s no public sector.
2. No International Trade:
   • Net exports (XN) is zero due to lack of imports and exports.

Components of Aggregate Expenditure

• Sectors Involved:
  • Households: Measured as personal consumption expenditure (C).
  • Private Sector: Measured as gross private domestic investment (IG).

Investment in the Economy

• Investment Expenditure (IG):
  • Determined from the investment demand curve.
  • Assumed to be independent of real GDP.
• Real GDP and Investment:
  • Real GDP on horizontal axis, Investment on vertical axis.
  • Investment is fixed regardless of changes in real GDP.

Investment Demand Curve

• Characteristics:
  • Downward sloping based on expected rate of returns.
  • Real interest rate intersects with investment demand curve to determine equilibrium IG.

Aggregate Expenditure Equation

• In a private, closed economy:
  • Aggregate Expenditure (AE) = C + IG

Relationship Between Real GDP and Disposable Income

• Without Public Sector:
  • Real GDP equals disposable income (DI).
  • DI is the sum of consumption and savings.

Equilibrium Condition

• Keynesian Perspective:
  • Aggregate expenditure should equal total production.
  • Equilibrium: Real GDP = Aggregate Expenditure.
• Equilibrium Condition:
  • Savings = Planned Investment (no unplanned inventory changes).
  • Consumption appears on both sides of the equation and cancels out.

Conclusion

• Savings Equals Investment:
  • In equilibrium, savings must match planned investment.
  • Importance of no unplanned changes in inventories.