0:00:00.603,0:00:03.270
Let's think about what[br]happens to an IS curve

0:00:03.270,0:00:08.103
when government spending goes up.

0:00:08.103,0:00:13.183
To think about that, let's[br]first draw our Keynesian cross.

0:00:13.183,0:00:16.210
On the vertical axis over here,

0:00:16.210,0:00:19.014
we have aggregate expenditures.

0:00:19.014,0:00:20.836
In the horizontal axis right over here,

0:00:20.836,0:00:22.381
wee have aggregate income.

0:00:22.381,0:00:23.625
These are really just 2 ways

0:00:23.625,0:00:25.718
of talking about GDP.

0:00:25.718,0:00:27.789
We are thinking, we actually[br]want all of the points

0:00:27.789,0:00:29.386
where the economies and equilibrium

0:00:29.386,0:00:31.599
where income is equal to expenditures.

0:00:31.599,0:00:33.848
That's why we draw that line of slope 1,

0:00:33.848,0:00:35.066
that's all of the points

0:00:35.066,0:00:36.978
where income is equal expenditures.

0:00:36.978,0:00:39.982
Where is economy is in[br]some type of equilibrium

0:00:39.982,0:00:41.483
or in equilibrium.

0:00:41.483,0:00:43.394
Then we think about planned expenditures.

0:00:43.394,0:00:47.648
Planned expenditures, we've[br]done this multiple times,

0:00:47.648,0:00:51.118
it's equal to aggregate consumer spending

0:00:51.118,0:00:55.318
which is a function of income minus taxes.

0:00:55.318,0:00:57.451
Or it's a function of disposable income.

0:00:57.451,0:00:59.394
We're not seeing C x Y - T,

0:00:59.394,0:01:02.230
we're seeing C is a function of Y - T.

0:01:02.230,0:01:04.313
This is one way of talking[br]about consumption function.

0:01:04.313,0:01:06.811
We assume it's linear in[br]this video and another

0:01:06.811,0:01:07.918
but it's doesn't have to be,

0:01:07.918,0:01:09.316
it could be a curve of some kind.

0:01:09.316,0:01:12.253
Then we have our planned investment,

0:01:12.253,0:01:14.479
plus planned investment

0:01:14.479,0:01:18.445
which we're assuming that[br]we're sitting at some,

0:01:18.445,0:01:21.515
that our real interest[br]rates are fixed right now.

0:01:21.515,0:01:26.315
Planned investment plus[br]government spending

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and then we could even[br]throw net exports out there

0:01:29.315,0:01:31.935
if we assume that we have[br]some type of an open economy.

0:01:31.935,0:01:34.105
This curve, our plan investment,

0:01:34.105,0:01:36.602
this is all a review of[br]the Keynesian cross videos,

0:01:36.602,0:01:40.666
it might look something like this

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and we get to our[br]equilibrium level of GDP.

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We can also use this information

0:01:48.782,0:01:51.321
given that we were sitting[br]here at interest rate r1

0:01:51.321,0:01:56.451
to start, to at least plot[br]one point on our IS curve.

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Let's draw at least point on our IS curve

0:01:59.185,0:02:02.119
and hopefully you feel good[br]about the general shape of it

0:02:02.119,0:02:05.450
and then we could think about[br]how the IS curve might shift.

0:02:05.450,0:02:07.387
Here, we have real interest rates.

0:02:07.387,0:02:09.014
We're trying to relate real interest rates

0:02:09.014,0:02:11.266
to aggregate GDP.

0:02:11.266,0:02:13.847
We just showed that[br]when real interest rates

0:02:13.847,0:02:14.844
are sitting at r1,

0:02:14.844,0:02:19.592
if this is r1 right over here.

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If real interest rates are sitting at r1,

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we know that the aggregate[br]level of output or income

0:02:24.097,0:02:25.852
is that point right over there.

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We could just drop that down

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and so it is this level right over here.

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When real interest rates[br]are r1 this is our output.

0:02:34.094,0:02:37.182
That is a point on our IS curve.

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We can draw the entire IS curve

0:02:39.782,0:02:46.051
which might look something like that,

0:02:46.051,0:02:47.513
that is our entire IS curve.

0:02:47.513,0:02:49.045
If we kept changing this,

0:02:49.045,0:02:52.113
if we kept trying this out for[br]different real interest rates

0:02:52.113,0:02:53.426
we could plot more and more

0:02:53.426,0:02:56.181
of these points along the IS curve.

0:02:56.181,0:02:58.848
This is really thinking in terms of,

0:02:58.848,0:03:01.320
if real interest rates go up

0:03:01.320,0:03:03.594
then this whole expression will go down

0:03:03.594,0:03:05.432
then this thing will be shifted down

0:03:05.432,0:03:08.098
and so we would have less GDP.

0:03:08.098,0:03:10.096
If this gets shifted down

0:03:10.096,0:03:12.312
your equilibrium GDP might go over here.

0:03:12.312,0:03:14.051
At a higher real interest rate

0:03:14.051,0:03:17.116
you would have lower aggregate income.

0:03:17.116,0:03:19.433
That's how we actually thought[br]about plotting our IS curve.

0:03:19.433,0:03:22.260
Now, with all of that out of the way,

0:03:22.260,0:03:23.853
let's think about what happens

0:03:23.853,0:03:25.782
when government spending goes up.

0:03:25.782,0:03:28.683
Well, if government spending goes up,

0:03:28.683,0:03:30.804
if this piece right over here goes up,

0:03:30.804,0:03:35.517
that will shift our planned[br]expenditures up as well.

0:03:35.517,0:03:39.150
So your change in government[br]spending, change in G,

0:03:39.150,0:03:41.319
it would shift this curve up.

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Let me draw that a little bit neater.

0:03:43.731,0:03:45.652
It would shift this curve up

0:03:45.652,0:03:49.486
and you would get to a new level of income

0:03:49.486,0:03:52.070
or equilibrium level of real GDP.

0:03:52.070,0:03:55.181
That amount, this delta Y

0:03:55.181,0:03:56.852
which is this amount right over here.

0:03:56.852,0:03:58.649
It's actually going to be[br]equal to the multiplier

0:03:58.649,0:04:01.521
which is 1 minus the marginal[br]propensity to consume

0:04:01.521,0:04:05.985
times our change in government spending.

0:04:05.985,0:04:07.177
You don't have to worry[br]about this too much

0:04:07.177,0:04:08.653
for the sake of this video,

0:04:08.653,0:04:10.563
that's just a little bit of a review.

0:04:10.563,0:04:12.583
The whole reason why I'm[br]going this is we're saying,

0:04:12.583,0:04:14.855
"Look, assuming r1 didn't change

0:04:14.855,0:04:18.766
"and when we increased government spending

0:04:18.766,0:04:21.410
"it shifted GDP up by that amount."

0:04:21.410,0:04:22.724
When you increase government spending,

0:04:22.724,0:04:27.908
it shifted at r1, it[br]shifted it by that amount.

0:04:27.908,0:04:30.532
Well, that would be true at[br]any of the real interest rates

0:04:30.532,0:04:32.061
along the IS curve.

0:04:32.061,0:04:34.419
In general, if you increase[br]government spending

0:04:34.419,0:04:36.460
and you're not changing[br]any of this other stuff

0:04:36.460,0:04:39.753
then the IS curve would[br]shift to the right.

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If you decreased government spending

0:04:41.261,0:04:43.594
the IS curve would shift to the left.

0:04:43.594,0:04:45.460
With that in our toolkit now,

0:04:45.460,0:04:46.530
we can think about

0:04:46.530,0:04:48.419
how a change in government spending

0:04:48.419,0:04:52.417
might change our equilibrium[br]point in our IS-LM model.

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Let's do that.

0:04:54.126,0:04:56.994
Once again, real interest rates.

0:04:56.994,0:05:02.667
Here we have aggregate income or real GDP

0:05:02.667,0:05:05.200
and then we have our IS curve.

0:05:05.200,0:05:08.417
Our IS curve looks something like that.

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Our LM curve, I will do it in magenta.

0:05:12.501,0:05:16.864
Our LM curve might look[br]something like that.

0:05:16.864,0:05:19.664
So, if we have a increase[br]in government spending,

0:05:19.664,0:05:24.083
we already saw the IS[br]curve shift to the right.

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I want to do that in the same color.

0:05:25.414,0:05:26.468
It shift to the right

0:05:26.468,0:05:29.003
and it might look something like that.

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If our old equilibrium real[br]interest rate was sitting here

0:05:33.458,0:05:35.664
and equilibrium income was sitting here,

0:05:35.664,0:05:38.129
we saw that by increasing[br]the government spending

0:05:38.129,0:05:42.133
our new equilibrium GDP is higher

0:05:42.133,0:05:45.597
and our new equilibrium[br]interest rate is higher

0:05:45.597,0:05:47.927
just by the shift to the IS curve.

0:05:47.927,0:05:49.004
Now, you might be saying,

0:05:49.004,0:05:50.727
"Okay Sally, you've been[br]focusing on the IS curve

0:05:50.727,0:05:52.799
"but does an increase[br]in government spending,

0:05:52.799,0:05:55.126
"does it affect the LM curve?

0:05:55.126,0:05:56.724
"A change in physical policy,

0:05:56.724,0:05:58.419
"does that affect the LM curve?"

0:05:58.419,0:05:59.746
We're not talking about[br]printing more money,

0:05:59.746,0:06:01.794
we're talking about the[br]government spending more,

0:06:01.794,0:06:03.498
increasing its budget.

0:06:03.498,0:06:04.665
Remember, the LM curve,

0:06:04.665,0:06:08.057
it's driven by people's[br]liquidity preferences.

0:06:08.057,0:06:09.929
At different levels of GDP,

0:06:09.929,0:06:11.669
how much do they want to hold money

0:06:11.669,0:06:13.666
and how much would you[br]have to pay for them

0:06:13.666,0:06:15.927
in terms of interest for[br]them to depart with it?

0:06:15.927,0:06:17.661
How much interest are they willing to pay

0:06:17.661,0:06:19.666
to get access to money at[br]different levels of GDP?

0:06:19.666,0:06:21.831
That's not really impacted[br]by government spending,

0:06:21.831,0:06:24.999
and it's also impacted[br]by the money supply,

0:06:24.999,0:06:26.669
by the amount of money that are out there

0:06:26.669,0:06:28.927
and just general levels of prices.

0:06:28.927,0:06:30.395
You could start to think about,

0:06:30.395,0:06:31.466
"Oh, doesn't government spending

0:06:31.466,0:06:32.756
"affect the prices in the long run?"

0:06:32.756,0:06:34.725
But if we just hold a lot[br]of those things constant

0:06:34.725,0:06:35.927
especially in the short-term,

0:06:35.927,0:06:38.127
especially if you hold prices constant,

0:06:38.127,0:06:41.196
fiscal policy is not going[br]to change the LM curve.

0:06:41.196,0:06:44.261
Monetary policy, the money[br]supply part, that could

0:06:44.261,0:06:46.597
or people's liquidity preferences could.

0:06:46.597,0:06:48.393
But just government policy by itself,

0:06:48.393,0:06:51.003
fiscal policy by itself won't change it.

0:06:51.003,0:06:55.468
In this model, just not trying[br]to get too over-complicated.

0:06:55.468,0:06:59.528
When government spending[br]goes up, when G goes up,

0:06:59.528,0:07:01.329
it would shift the IS curve to the right.

0:07:01.329,0:07:03.084
Increase in real interest rates,

0:07:03.084,0:07:07.084
increase in real GDP[br]according to this model.