This video introduces you to first version of aggregate expenditure model that is for private and closed economy. Private aggregate expenditure model simply measures the spending by all the sectors in the economy. So private economy means no public sector.
When there is no public sector, there is no government spending or G goes to zero. And without public sector, there won't be any taxes in the economy. Second thing is closed economy means no international trade, no exports or imports that makes the net exports or XN actually go to zero.
Now if you want to measure the aggregate expenditure in the economy comes from only two sectors. One is households, second is from the private sector. Spending by the households are consumers in the economies measured as personal consumption expenditure. We show it as C. Whereas spending by the private sector we measure it as grass private domestic investment or simply investment expenditure.
Show it as IG. So it is realized as the equilibrium level of investment from the investment demand curve and is assumed to be independent of real GDP. What do we actually mean? Suppose if real GDP is changing.
Let's say if I'm considering real GDP on the horizontal axis. If I take investment on the vertical axis, it has to be fixed. That means no matter how much I invest, how much real GDP investment is going to be fixed. That is another assumption.
Where do we realize this investment? If you remember from the last chapter, investment demand curve actually downward sloping based on expected rate of returns. That's what we show it as ID.
Wherever is the interest rate that intersects with this, okay, so this is what we show it as real interest rates. Okay, so the point where it intersects with the real interest rate, that particular point. we realize the equilibrium amount of IG.
This IG will be fixed no matter what real GDP is. Using that IG value, we actually estimate overall aggregate expenditure in the economy. If it is private and closed economy, we can show aggregate expenditure is simply C plus IG. Without public sector, there are no taxes.
That means whatever is the output produced, which is real GDP, has to be equal to disposable income in the economy. So, we can simply show real GDP is same as disposable income. Disposable income is the addition of consumption and savings. Disposable income essentially means the amount of money that is left for the households after paying the taxes.
If there is no taxes, whatever is produced is equal to whatever is the disposable income. Now, if market is at the... equilibrium.
Keynes thought the spending in the economy should be equal to whatever is the production in the economy. So overall spending in the economy is aggregate expenditure. Total output produced in the economy is real GDP.
And also there shouldn't be any unplanned changes in the inventories. I'll come to that point later. Just looking at the equilibrium, simply real GDP should be equal to aggregate expenditure.
Aggregate expenditure in the private and closed economy is simply consumption and investment. Whereas real GDP is equal to consumption and savings without any taxes in the economy, that is private and closed economy. So if you look at this, we can actually, consumption is same both sides. We can get rid of consumption on both sides. What is it showing?
If economy is at the equilibrium, if there is no un... planned changes in the inventories which is part of the investment that means simple savings in the economy should be equal to planned changes in the planned investment in the economy that's what shows the equilibrium so savings in the economy should be equal to investment in the economy investment in the economy is simply planned investment and no unplanned changes in terms of inventories