AE Model: Private Open Economy: Study with Video Lessons, Practice Problems & Examples

The aggregate expenditures model in a private open economy illustrates the relationship between spending and production without government influence. Key components include consumption, investment, and net exports, with the absence of government purchases. The equilibrium occurs where aggregate expenditures equal GDP, represented graphically by the intersection of the aggregate expenditures line and the 45-degree line. The consumption function can be expressed as $C=2+0.5Y$, while aggregate expenditures are calculated as $\mathrm{AE}=C+I+\mathrm{NX}$.

Private Open Economy

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 going to be taking out variables here. Aggregate expenditures model, well this describes the relationship between spending and production. Okay. So 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 does not have a government, right? But it does have trade in this case. So private closed economy, the closed and the open had to do with the trade. And the private versus let's say a public economy would have 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 GDP and then we're going to 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 net 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-degree 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 going to 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? They just simplify it in these economies, right? These are just simpler versions of it. So what we have here again is we're going to have our consumption function C = 2 + 1 2 y and then we're going to add investment and add net exports to it. So consumption, just like we've been defining, right? There's going to be this 2 when there's no GDP at all. We've got 2. And as we add GDP, it's gonna go up at this rate of half of that. So if we add 2 GDP, it's gonna add 1 more to our consumption. And again, one more to our consumption and it's gonna be going up at that rate. So this is our consumption function right here. Right? We're just graphing the line 2 + y 0.5 , and that's our consumption right there. So let's go ahead and add investment to it, which is going to be C + I = 3 + y 0.5 . Right now, our intercept here is at 3 and it goes up at the same rate. The slope is the same. As we add 2, we're gonna add as 2 more GDP, there's going to 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+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. We're trading with other countries. There's just no government in this private open economy. Alright. So C I + NX . Well, this is going to 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 2 + 1 + y 0.5 + 0.5 gives us 3.5 for 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 going to look something like that. And this is going to be aggregate expenditures equals C+I+NX. Okay? Notice no government purchases in this economy. That's it. C+NX. And we can find our macroeconomic equilibrium just like before on that 45-degree line. And that's going to be right here approximately where aggregate expenditures equals 7 and our GDP equals 7. So by producing $7 billion worth of goods, there would be $7 billion worth 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.

Here’s what students ask on this topic:

What is the aggregate expenditures model in a private open economy?

The aggregate expenditures (AE) model in a private open economy describes the relationship between spending and production without government influence. Key components include consumption (C), investment (I), and net exports (NX). The model excludes government purchases. The equilibrium occurs where aggregate expenditures equal GDP, represented graphically by the intersection of the AE line and the 45-degree line. The consumption function can be expressed as $C=2+0.5Y$, while aggregate expenditures are calculated as $\mathrm{AE}=C+I+\mathrm{NX}$.

How is equilibrium determined in a private open economy using the AE model?

In a private open economy, equilibrium is determined where aggregate expenditures (AE) equal GDP. This is graphically represented by the intersection of the AE line and the 45-degree line. The AE line includes consumption (C), investment (I), and net exports (NX), but excludes government purchases. The equilibrium point indicates that the total spending in the economy matches the total production, ensuring that there is no unplanned inventory accumulation or depletion. Mathematically, equilibrium is found where $\mathrm{AE}=\mathrm{GDP}$.

What components are included in the aggregate expenditures in a private open economy?

In a private open economy, the components of aggregate expenditures (AE) include consumption (C), investment (I), and net exports (NX). Government purchases are excluded since the model assumes no government influence. The formula for aggregate expenditures in this context is $\mathrm{AE}=C+I+\mathrm{NX}$. Consumption is typically expressed as a function of GDP, such as $C=2+0.5Y$, where Y is GDP.

How does the multiplier effect work in a private open economy?

In a private open economy, the multiplier effect refers to the amplification of initial changes in spending on GDP. When investment (I) or net exports (NX) change, it leads to a multiplied impact on GDP due to the consumption function. For example, an increase in investment increases income, which in turn increases consumption, leading to further increases in income and consumption. The size of the multiplier depends on the marginal propensity to consume (MPC). The formula for the multiplier is $\frac{1}{1-\mathrm{MPC}}$.

What is the consumption function in a private open economy?

The consumption function in a private open economy represents the relationship between consumption (C) and GDP (Y). It is typically expressed as $C=2+0.5Y$, where 2 is the autonomous consumption (consumption when GDP is zero) and 0.5 is the marginal propensity to consume (MPC). This function indicates that for every additional unit of GDP, consumption increases by 0.5 units.