# 3. A graphical approach to equilibrium GDP In a private closedeconomy The following graph shows the consumption function (C) for a hypothetical private closed economy and a 45-degree line along

3. A graphical approach to equilibrium GDP In a private closedeconomy

The following graph shows the consumption function (C) for a hypothetical private closed economy and a 45-degree line along which aggregate

expenditure equals real GDP (AE=Y), Recall that a private closed economy does not have government and does not trade with the rest of the world (so

G-D and (X-M)=0). In a private closed economy, real GDP is equal to disposable income.

At the current real interest rate, the level of investment in this economy is equal to $75 billion at each level of real GDP. Use the blue line (circle

symbols) to plot this economy’s initial aggregate expenditure line, (C + 1). Then, use the black point (X symbol) to indicate this economy’s initial

equilibrium output. Dashed drop lines will automatically extend to both axes. ( nt: You can see two of the coordinates along the consumption

function by mousing over the green triangles on the graph.)

750

AF BY

Aggregate Expand hen

Expenditures

450 At the current real interest rate, the level of investment in this economy is equal to $75 billion at each level of real GDP. Use the blue line (circle

symbols) to plot this economy’s initial aggregate expenditure line, (C + 1). Then, use the black point (X symbol) to indicate this economy’s initial

equilibrium output. Dashed drop lines will automatically extend to both axes. (nt: You can see two of the coordinates along the consumption

function by mousing over the green triangles on the graph.)

O-

AE -Y

Aggregate Expenditure

C

Aggregate Expenditures

109 : 390 309

HOM OOP At the level of equilibrium output you just indicated, the level of saving is equal to

At an output level of $700 billion, aggregate expenditure will be

real GDP and firms will experience

in business inventories. Firms will respond to this situation by:

Increasing production

Leaving production unchanged

Decreasing production

At an output level of $650 billion, aggregate expenditure will be

real GDP and firms will experience

In business Inventories. Firms will respond to this situation by ;

Decreasing production

Leaving production unchanged

Increasing production

Suppose the real interest rate rises and the level of investment in this economy decreases by $25 billion. Use the blue line (circle symbols) to show

the economy’s aggregate expenditure line, (C + 1), after the decrease in investment. Then use the gray point (star symbol) to show the economy’s

new equilibrium output. Dashed drop lines will extend to both axes.

nt: Start with your aggregate expenditure line from the previous graph, Make sure the slope of the aggregate expenditure line is the same as the

previous aggregate expenditure line you just plotted, You can check the slope of the line by clicking on the line after you plot it. nt: Start with your aggregate expenditure line from the previous graph, Make sure the slope of the aggregate expenditure line is the same as the

previous aggregate expenditure line you just plotted. You can check the slope of the line by clicking on the line after you plot it.

700

Aggregate Expenditure with higher real Interest rule

650

Equilibrium with higher real interest rate

200

180

100

300

TOO. BOO

Real GOP

The simple spending multiplier for this private closed economy is

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