WEBVTT 00:00:00.603 --> 00:00:03.270 Let's think about what happens to an IS curve 00:00:03.270 --> 00:00:08.103 when government spending goes up. 00:00:08.103 --> 00:00:13.183 To think about that, let's first draw our Keynesian cross. 00:00:13.183 --> 00:00:16.210 On the vertical axis over here, 00:00:16.210 --> 00:00:19.014 we have aggregate expenditures. 00:00:19.014 --> 00:00:20.836 In the horizontal axis right over here, 00:00:20.836 --> 00:00:22.381 wee have aggregate income. 00:00:22.381 --> 00:00:23.625 These are really just 2 ways 00:00:23.625 --> 00:00:25.718 of talking about GDP. 00:00:25.718 --> 00:00:27.789 We are thinking, we actually want all of the points 00:00:27.789 --> 00:00:29.386 where the economies and equilibrium 00:00:29.386 --> 00:00:31.599 where income is equal to expenditures. 00:00:31.599 --> 00:00:33.848 That's why we draw that line of slope 1, 00:00:33.848 --> 00:00:35.066 that's all of the points 00:00:35.066 --> 00:00:36.978 where income is equal expenditures. 00:00:36.978 --> 00:00:39.982 Where is economy is in some type of equilibrium 00:00:39.982 --> 00:00:41.483 or in equilibrium. 00:00:41.483 --> 00:00:43.394 Then we think about planned expenditures. 00:00:43.394 --> 00:00:47.648 Planned expenditures, we've done this multiple times, 00:00:47.648 --> 00:00:51.118 it's equal to aggregate consumer spending 00:00:51.118 --> 00:00:55.318 which is a function of income minus taxes. 00:00:55.318 --> 00:00:57.451 Or it's a function of disposable income. 00:00:57.451 --> 00:00:59.394 We're not seeing C x Y - T, 00:00:59.394 --> 00:01:02.230 we're seeing C is a function of Y - T. 00:01:02.230 --> 00:01:04.313 This is one way of talking about consumption function. 00:01:04.313 --> 00:01:06.811 We assume it's linear in this video and another 00:01:06.811 --> 00:01:07.918 but it's doesn't have to be, 00:01:07.918 --> 00:01:09.316 it could be a curve of some kind. 00:01:09.316 --> 00:01:12.253 Then we have our planned investment, 00:01:12.253 --> 00:01:14.479 plus planned investment 00:01:14.479 --> 00:01:18.445 which we're assuming that we're sitting at some, 00:01:18.445 --> 00:01:21.515 that our real interest rates are fixed right now. 00:01:21.515 --> 00:01:26.315 Planned investment plus government spending 00:01:26.315 --> 00:01:29.315 and then we could even throw net exports out there 00:01:29.315 --> 00:01:31.935 if we assume that we have some type of an open economy. 00:01:31.935 --> 00:01:34.105 This curve, our plan investment, 00:01:34.105 --> 00:01:36.602 this is all a review of the Keynesian cross videos, 00:01:36.602 --> 00:01:40.666 it might look something like this 00:01:40.666 --> 00:01:46.514 and we get to our equilibrium level of GDP. 00:01:46.514 --> 00:01:48.782 We can also use this information 00:01:48.782 --> 00:01:51.321 given that we were sitting here at interest rate r1 00:01:51.321 --> 00:01:56.451 to start, to at least plot one point on our IS curve. 00:01:56.451 --> 00:01:59.185 Let's draw at least point on our IS curve 00:01:59.185 --> 00:02:02.119 and hopefully you feel good about the general shape of it 00:02:02.119 --> 00:02:05.450 and then we could think about how the IS curve might shift. 00:02:05.450 --> 00:02:07.387 Here, we have real interest rates. 00:02:07.387 --> 00:02:09.014 We're trying to relate real interest rates 00:02:09.014 --> 00:02:11.266 to aggregate GDP. 00:02:11.266 --> 00:02:13.847 We just showed that when real interest rates 00:02:13.847 --> 00:02:14.844 are sitting at r1, 00:02:14.844 --> 00:02:19.592 if this is r1 right over here. 00:02:19.592 --> 00:02:21.323 If real interest rates are sitting at r1, 00:02:21.323 --> 00:02:24.097 we know that the aggregate level of output or income 00:02:24.097 --> 00:02:25.852 is that point right over there. 00:02:25.852 --> 00:02:27.379 We could just drop that down 00:02:27.379 --> 00:02:30.781 and so it is this level right over here. 00:02:30.781 --> 00:02:34.094 When real interest rates are r1 this is our output. 00:02:34.094 --> 00:02:37.182 That is a point on our IS curve. 00:02:37.182 --> 00:02:39.782 We can draw the entire IS curve 00:02:39.782 --> 00:02:46.051 which might look something like that, 00:02:46.051 --> 00:02:47.513 that is our entire IS curve. 00:02:47.513 --> 00:02:49.045 If we kept changing this, 00:02:49.045 --> 00:02:52.113 if we kept trying this out for different real interest rates 00:02:52.113 --> 00:02:53.426 we could plot more and more 00:02:53.426 --> 00:02:56.181 of these points along the IS curve. 00:02:56.181 --> 00:02:58.848 This is really thinking in terms of, 00:02:58.848 --> 00:03:01.320 if real interest rates go up 00:03:01.320 --> 00:03:03.594 then this whole expression will go down 00:03:03.594 --> 00:03:05.432 then this thing will be shifted down 00:03:05.432 --> 00:03:08.098 and so we would have less GDP. 00:03:08.098 --> 00:03:10.096 If this gets shifted down 00:03:10.096 --> 00:03:12.312 your equilibrium GDP might go over here. 00:03:12.312 --> 00:03:14.051 At a higher real interest rate 00:03:14.051 --> 00:03:17.116 you would have lower aggregate income. 00:03:17.116 --> 00:03:19.433 That's how we actually thought about plotting our IS curve. 00:03:19.433 --> 00:03:22.260 Now, with all of that out of the way, 00:03:22.260 --> 00:03:23.853 let's think about what happens 00:03:23.853 --> 00:03:25.782 when government spending goes up. 00:03:25.782 --> 00:03:28.683 Well, if government spending goes up, 00:03:28.683 --> 00:03:30.804 if this piece right over here goes up, 00:03:30.804 --> 00:03:35.517 that will shift our planned expenditures up as well. 00:03:35.517 --> 00:03:39.150 So your change in government spending, change in G, 00:03:39.150 --> 00:03:41.319 it would shift this curve up. 00:03:41.319 --> 00:03:43.731 Let me draw that a little bit neater. 00:03:43.731 --> 00:03:45.652 It would shift this curve up 00:03:45.652 --> 00:03:49.486 and you would get to a new level of income 00:03:49.486 --> 00:03:52.070 or equilibrium level of real GDP. 00:03:52.070 --> 00:03:55.181 That amount, this delta Y 00:03:55.181 --> 00:03:56.852 which is this amount right over here. 00:03:56.852 --> 00:03:58.649 It's actually going to be equal to the multiplier 00:03:58.649 --> 00:04:01.521 which is 1 minus the marginal propensity to consume 00:04:01.521 --> 00:04:05.985 times our change in government spending. 00:04:05.985 --> 00:04:07.177 You don't have to worry about this too much 00:04:07.177 --> 00:04:08.653 for the sake of this video, 00:04:08.653 --> 00:04:10.563 that's just a little bit of a review. 00:04:10.563 --> 00:04:12.583 The whole reason why I'm going this is we're saying, 00:04:12.583 --> 00:04:14.855 "Look, assuming r1 didn't change 00:04:14.855 --> 00:04:18.766 "and when we increased government spending 00:04:18.766 --> 00:04:21.410 "it shifted GDP up by that amount." 00:04:21.410 --> 00:04:22.724 When you increase government spending, 00:04:22.724 --> 00:04:27.908 it shifted at r1, it shifted it by that amount. 00:04:27.908 --> 00:04:30.532 Well, that would be true at any of the real interest rates 00:04:30.532 --> 00:04:32.061 along the IS curve. 00:04:32.061 --> 00:04:34.419 In general, if you increase government spending 00:04:34.419 --> 00:04:36.460 and you're not changing any of this other stuff 00:04:36.460 --> 00:04:39.753 then the IS curve would shift to the right. 00:04:39.753 --> 00:04:41.261 If you decreased government spending 00:04:41.261 --> 00:04:43.594 the IS curve would shift to the left. 00:04:43.594 --> 00:04:45.460 With that in our toolkit now, 00:04:45.460 --> 00:04:46.530 we can think about 00:04:46.530 --> 00:04:48.419 how a change in government spending 00:04:48.419 --> 00:04:52.417 might change our equilibrium point in our IS-LM model. 00:04:52.417 --> 00:04:54.126 Let's do that. 00:04:54.126 --> 00:04:56.994 Once again, real interest rates. 00:04:56.994 --> 00:05:02.667 Here we have aggregate income or real GDP 00:05:02.667 --> 00:05:05.200 and then we have our IS curve. 00:05:05.200 --> 00:05:08.417 Our IS curve looks something like that. 00:05:08.417 --> 00:05:12.501 Our LM curve, I will do it in magenta. 00:05:12.501 --> 00:05:16.864 Our LM curve might look something like that. 00:05:16.864 --> 00:05:19.664 So, if we have a increase in government spending, 00:05:19.664 --> 00:05:24.083 we already saw the IS curve shift to the right. 00:05:24.083 --> 00:05:25.414 I want to do that in the same color. 00:05:25.414 --> 00:05:26.468 It shift to the right 00:05:26.468 --> 00:05:29.003 and it might look something like that. 00:05:29.003 --> 00:05:33.458 If our old equilibrium real interest rate was sitting here 00:05:33.458 --> 00:05:35.664 and equilibrium income was sitting here, 00:05:35.664 --> 00:05:38.129 we saw that by increasing the government spending 00:05:38.129 --> 00:05:42.133 our new equilibrium GDP is higher 00:05:42.133 --> 00:05:45.597 and our new equilibrium interest rate is higher 00:05:45.597 --> 00:05:47.927 just by the shift to the IS curve. 00:05:47.927 --> 00:05:49.004 Now, you might be saying, 00:05:49.004 --> 00:05:50.727 "Okay Sally, you've been focusing on the IS curve 00:05:50.727 --> 00:05:52.799 "but does an increase in government spending, 00:05:52.799 --> 00:05:55.126 "does it affect the LM curve? 00:05:55.126 --> 00:05:56.724 "A change in physical policy, 00:05:56.724 --> 00:05:58.419 "does that affect the LM curve?" 00:05:58.419 --> 00:05:59.746 We're not talking about printing more money, 00:05:59.746 --> 00:06:01.794 we're talking about the government spending more, 00:06:01.794 --> 00:06:03.498 increasing its budget. 00:06:03.498 --> 00:06:04.665 Remember, the LM curve, 00:06:04.665 --> 00:06:08.057 it's driven by people's liquidity preferences. 00:06:08.057 --> 00:06:09.929 At different levels of GDP, 00:06:09.929 --> 00:06:11.669 how much do they want to hold money 00:06:11.669 --> 00:06:13.666 and how much would you have to pay for them 00:06:13.666 --> 00:06:15.927 in terms of interest for them to depart with it? 00:06:15.927 --> 00:06:17.661 How much interest are they willing to pay 00:06:17.661 --> 00:06:19.666 to get access to money at different levels of GDP? 00:06:19.666 --> 00:06:21.831 That's not really impacted by government spending, 00:06:21.831 --> 00:06:24.999 and it's also impacted by the money supply, 00:06:24.999 --> 00:06:26.669 by the amount of money that are out there 00:06:26.669 --> 00:06:28.927 and just general levels of prices. 00:06:28.927 --> 00:06:30.395 You could start to think about, 00:06:30.395 --> 00:06:31.466 "Oh, doesn't government spending 00:06:31.466 --> 00:06:32.756 "affect the prices in the long run?" 00:06:32.756 --> 00:06:34.725 But if we just hold a lot of those things constant 00:06:34.725 --> 00:06:35.927 especially in the short-term, 00:06:35.927 --> 00:06:38.127 especially if you hold prices constant, 00:06:38.127 --> 00:06:41.196 fiscal policy is not going to change the LM curve. 00:06:41.196 --> 00:06:44.261 Monetary policy, the money supply part, that could 00:06:44.261 --> 00:06:46.597 or people's liquidity preferences could. 00:06:46.597 --> 00:06:48.393 But just government policy by itself, 00:06:48.393 --> 00:06:51.003 fiscal policy by itself won't change it. 00:06:51.003 --> 00:06:55.468 In this model, just not trying to get too over-complicated. 00:06:55.468 --> 00:06:59.528 When government spending goes up, when G goes up, 00:06:59.528 --> 00:07:01.329 it would shift the IS curve to the right. 00:07:01.329 --> 00:07:03.084 Increase in real interest rates, 00:07:03.084 --> 00:07:07.084 increase in real GDP according to this model.