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AE Model: Private Closed Economy quiz

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  • What does a private closed economy exclude from its aggregate expenditures model?
    It excludes government spending and international trade (net exports).
  • In the aggregate expenditures model, what two components make up total spending in a private closed economy?
    Total spending is made up of consumption (C) and investment (I).
  • At macroeconomic equilibrium in the AE model, what is the relationship between aggregate expenditures and GDP?
    Aggregate expenditures equal GDP at equilibrium.
  • What is the base amount of consumption in the consumption function, and why does it exist?
    The base amount of consumption exists because people need to consume for survival, even if income is zero.
  • How does the marginal propensity to consume (MPC) affect the consumption function?
    The MPC determines how much consumption increases as income increases.
  • In this model, how is investment treated?
    Investment is considered constant.
  • What is the formula for aggregate expenditures in a private closed economy?
    Aggregate expenditures are represented as C + I.
  • On the AE model graph, what do the axes represent?
    The x-axis represents GDP (production), and the y-axis represents aggregate expenditures (spending).
  • How does adding investment to the consumption function affect the aggregate expenditures line on the graph?
    It shifts the consumption line upward by the amount of investment, but the slope remains the same.
  • What does the 45-degree line on the AE model graph represent?
    It represents all points where aggregate expenditures equal GDP.
  • Where is macroeconomic equilibrium found on the AE model graph?
    It is found where the aggregate expenditures line (C + I) intersects the 45-degree line.
  • If the base consumption is 2 and investment is 1, what is the new intercept of the aggregate expenditures line?
    The new intercept is 3 (2 from consumption plus 1 from investment).
  • What happens to the slope of the aggregate expenditures line when investment is added?
    The slope stays the same; only the intercept increases.
  • Why is the private closed economy model considered simpler than the full AE model?
    Because it excludes government spending and net exports, focusing only on consumption and investment.
  • What is the significance of the point where aggregate expenditures equal 6 and GDP equals 6 in the model example?
    It indicates macroeconomic equilibrium, where total spending matches total production.