In a closed private economy, where there is neither a government nor foreign sector, aggregate expenditures are equal to consumption expenditures plus planned gross investment expenditures. The equilibrium output of such an economy is that level of output at which the total amount of spending is just equal to the amount produced, or GDP. That is, equilibrium GDP = C + Ig. Consumption expenditures rise with GDP while planned gross investment expenditures are independent of the level of GDP. The aggregate expenditures schedule shows the amount of desired spending at each possible output level and can be used to determine the equilibrium level of output.
|Exploration: What level of GDP is sustainable as an equilibrium?|
The graph illustrates the relationship between real aggregate expenditures – consumption plus planned gross investment – and the level of real GDP, labeled “Y” on the graph. The graph also includes a 45° line. All points on this line share the feature that spending, measured on the vertical axis, is equal to GDP, measured on the horizontal axis. As such, points on this line are a graphical statement of the equilibrium condition that planned expenditures equal GDP. To use the graph, click and drag on the blue triangle to select a level of GDP. As you drag the triangle, note the “Y” labels on both axes. These move together along the 45° line to indicate the same level of GDP, representing potential equilibria. Click on the Income Adjustment button to observe the economy’s readjustment to equilibrium.