Final answer:
Equilibrium GDP in a private economy is graphically represented by the intersection of the aggregate expenditure function and the 45-degree line in the Keynesian cross diagram. The aggregate expenditure function includes consumption, investment, government spending, exports, and imports. Adding government spending to the model shifts the expenditure curve upward, indicating a higher equilibrium GDP.
Step-by-step explanation:
The concept of equilibrium GDP in a private economy can be graphically represented using the Keynesian cross diagram or the expenditure-output model. This model sets out to find the point at which aggregate expenditure equals national income, indicating an equilibrium where the economy's total spending matches its total output.
With a Marginal Propensity to Consume (MPC) of 0.75, the slope of the aggregate expenditure function is determined by multiplying this MPC by the increase in national income. Additionally, we consider government spending, which is a component of aggregate expenditure that shifts the expenditure curve upward by a fixed amount, in this case, $637 billion. The aggregate expenditure function is thus AE = C + I + G + X - M, where C is consumption (a function of disposable income), I is investment (assumed to be autonomous and thus independent of GDP), G is government spending, X is exports, and M is imports (which may be a function of national income).
On a graph with real GDP on the horizontal axis and aggregate expenditures on the vertical axis, you draw two key lines. The 45-degree line represents all points where aggregate expenditure equals national income. The aggregate expenditure curve represents the total spending in the economy at different levels of GDP. To construct this, we calculate the consumption function based on the MPC and disposable income, add fixed investment, government spending, and exports, and subtract imports. The intersection of the aggregate expenditure curve with the 45-degree line marks the equilibrium GDP.
When government purchases are added to the graph, the aggregate expenditure line shifts upward by the amount of the government spending, suggesting a higher level of equilibrium GDP due to the injection of government purchases into the economy. This graphical analysis is instrumental in understanding how different components of demand influence overall economic activity and helps policymakers determine fiscal policy measures.