WEBVTT

00:00:00.566 --> 00:00:02.900
In the last video we
hopefully got the intuition

00:00:02.900 --> 00:00:05.816
between how real interest rates

00:00:05.816 --> 00:00:08.002
might impact planned investment.

00:00:08.002 --> 00:00:11.233
We saw that if real
interest rates went up,

00:00:11.233 --> 00:00:15.484
then planned investment went down.

00:00:15.484 --> 00:00:17.204
If real interest rates went down,

00:00:17.204 --> 00:00:21.149
then planned investment went up.

00:00:21.149 --> 00:00:22.937
What we want to do in this video is

00:00:22.937 --> 00:00:25.067
take this conclusion right over here,

00:00:25.067 --> 00:00:28.150
this hopefully fairly intuitive
conclusion right over here

00:00:28.150 --> 00:00:30.150
and apply it to our Keynesian Cross

00:00:30.150 --> 00:00:31.734
and think about how real interest rates

00:00:31.734 --> 00:00:34.270
would effect overall planned expenditure

00:00:34.270 --> 00:00:35.783
and what that would do in a model

00:00:35.783 --> 00:00:37.982
like the Keynesian Cross,

00:00:37.982 --> 00:00:42.934
what that would do to our
equilibrium real GDPs.

00:00:42.934 --> 00:00:44.600
Just as a reminder,

00:00:44.600 --> 00:00:46.849
let's just draw our Keynesian Cross first,

00:00:46.849 --> 00:00:48.433
or parts of it.

00:00:48.433 --> 00:00:49.933
On this axis right over here,

00:00:49.933 --> 00:00:52.116
we have expenditures.

00:00:52.116 --> 00:00:55.267
This axis right over here,

00:00:55.267 --> 00:00:57.383
we have income.

00:00:57.383 --> 00:00:59.515
We know, from many videos now,

00:00:59.515 --> 00:01:01.515
that an economy is a equilibrium

00:01:01.515 --> 00:01:03.185
when income is equal,

00:01:03.185 --> 00:01:05.648
when aggregate real income

00:01:05.648 --> 00:01:07.868
is equal to aggregate real expenditures.

00:01:07.868 --> 00:01:10.357
Circular flow of GDP.

00:01:10.357 --> 00:01:11.273
Let's draw …

00:01:11.273 --> 00:01:13.450
Let me make a line that's all the points

00:01:13.450 --> 00:01:16.608
where Y is equal to expenditures.

00:01:16.608 --> 00:01:19.785
Along this 45 degree line right over here.

00:01:19.785 --> 00:01:21.358
This is our expenditures.

00:01:21.358 --> 00:01:22.608
At this point right over here,

00:01:22.608 --> 00:01:24.318
that should be the same value

00:01:24.318 --> 00:01:27.023
as what our aggregate income is.

00:01:27.023 --> 00:01:28.524
That's part of the Keynesian Cross.

00:01:28.524 --> 00:01:29.783
The other part is to actually

00:01:29.783 --> 00:01:32.607
plot planned expenditures relative to this

00:01:32.607 --> 00:01:33.941
and then see where they intersect.

00:01:33.941 --> 00:01:37.049
What the equilibrium for that
planned expenditure line?

00:01:37.049 --> 00:01:38.848
I'll write it here as ...

00:01:38.848 --> 00:01:41.049
I've written it in the past as planned.

00:01:41.049 --> 00:01:42.384
I just wrote out the word.

00:01:42.384 --> 00:01:45.651
Planned expenditures.

00:01:45.651 --> 00:01:51.858
We could write it as
expenditures planned, like that.

00:01:51.858 --> 00:01:55.784
It's equal to our aggregate consumption.

00:01:55.784 --> 00:01:57.117
Our aggregate consumption,

00:01:57.117 --> 00:02:01.116
we can write it as a function
of disposable income.

00:02:01.116 --> 00:02:02.983
Y - T is disposable income.

00:02:02.983 --> 00:02:05.583
Aggregat income minus aggregate taxes.

00:02:05.583 --> 00:02:07.117
I want to be very clear here.

00:02:07.117 --> 00:02:09.522
This is not saying C x Y - T.

00:02:09.522 --> 00:02:11.856
This is saying C is a function of Y - T.

00:02:11.856 --> 00:02:15.116
Give my a Y - T and I will give you a C.

00:02:15.116 --> 00:02:17.439
For the sake of our
Keynesian Cross analysis,

00:02:17.439 --> 00:02:18.715
and this is kind of kind
of what you would see

00:02:18.715 --> 00:02:20.359
in a traditional intro class,

00:02:20.359 --> 00:02:23.651
we assume that we have a
linear consumption function.

00:02:23.651 --> 00:02:25.716
We assume that our consumption functions.

00:02:25.716 --> 00:02:28.649
C as a function of disposable income.

00:02:28.649 --> 00:02:31.783
It might be something like
our autonomous consumption

00:02:31.783 --> 00:02:33.939
plus our marginal propensity to consume

00:02:33.939 --> 00:02:37.783
times our aggregate income, minus taxes.

00:02:37.783 --> 00:02:39.916
This right over here
really is multiplication.

00:02:39.916 --> 00:02:42.250
We could distribute this C 1.

00:02:42.250 --> 00:02:46.985
This is just saying C
as a function of Y - T.

00:02:46.985 --> 00:02:49.856
That's only one part of
planned expenditures.

00:02:49.856 --> 00:02:51.049
Above and beyond that,

00:02:51.049 --> 00:02:53.690
we have planned investment.

00:02:53.690 --> 00:02:55.607
We're talking about the
planned side of things.

00:02:55.607 --> 00:02:57.382
Now we know that planned investment ...

00:02:57.382 --> 00:03:00.450
In the past we viewed it as a constant,

00:03:00.450 --> 00:03:01.859
but now we know it can actually be

00:03:01.859 --> 00:03:05.381
a function of real interest rates.

00:03:05.381 --> 00:03:06.941
Above and beyond that,

00:03:06.941 --> 00:03:09.450
we have government expenditures

00:03:09.450 --> 00:03:11.522
and then net exports.

00:03:11.522 --> 00:03:14.117
For some given real interest rate,

00:03:14.117 --> 00:03:15.584
we can plot this line.

00:03:15.584 --> 00:03:17.190
The consumption function right over here

00:03:17.190 --> 00:03:20.984
is just a line with a
positive slope that intersects

00:03:20.984 --> 00:03:24.857
the vertical axis at some place up here.

00:03:24.857 --> 00:03:26.383
It has a positive intersect.

00:03:26.383 --> 00:03:28.316
All of these, for given interest rate,

00:03:28.316 --> 00:03:29.941
these are all going to be constant.

00:03:29.941 --> 00:03:34.050
Our planned expenditures would
look something like this.

00:03:34.050 --> 00:03:37.318
It might look something like that.

00:03:37.318 --> 00:03:40.608
This is YP.

00:03:40.608 --> 00:03:43.182
Let's call this YP_1.

00:03:43.182 --> 00:03:46.247
This is the YP we get when we pick …

00:03:46.247 --> 00:03:47.450
I'll just write ...

00:03:47.450 --> 00:03:49.190
I'll just rewrite the
whole thing over again.

00:03:49.190 --> 00:03:50.916
We have our consumption,

00:03:50.916 --> 00:03:53.716
which is a function of Y - T,

00:03:53.716 --> 00:03:56.858
plus the level of
planned investment at ...

00:03:56.858 --> 00:04:00.048
Let's say interest rate R1,

00:04:00.048 --> 00:04:01.856
so at some given interest rate,

00:04:01.856 --> 00:04:03.857
plus government spending,

00:04:03.857 --> 00:04:07.524
plus net exports.

00:04:07.524 --> 00:04:08.650
We see ...

00:04:08.650 --> 00:04:10.051
We've done this Keynesian Cross analysis

00:04:10.051 --> 00:04:11.916
several times now, already.

00:04:11.916 --> 00:04:14.783
This is our equilibrium level of GDP.

00:04:14.783 --> 00:04:17.251
This is where along our
planned expenditure line,

00:04:17.251 --> 00:04:20.784
where income is equal to expenditures,

00:04:20.784 --> 00:04:22.450
or output is equal to expenditures.

00:04:22.450 --> 00:04:25.191
We are equilibrium right over here.

00:04:25.191 --> 00:04:28.999
We're not eating into
inventories in an unplanned way

00:04:28.999 --> 00:04:31.398
and we're not building excessive inventory

00:04:31.398 --> 00:04:34.597
above and beyond what we had planned.

00:04:34.597 --> 00:04:35.998
Now, what I want to think about,

00:04:35.998 --> 00:04:43.731
what happens if interest
rates go from R1 to R2?

00:04:43.731 --> 00:04:47.315
What happens if interest
rates go from R1 to R2

00:04:47.315 --> 00:04:50.665
and in particular let's assume that R2?

00:04:50.665 --> 00:04:54.796
Now, we're going have
planned investment at R2

00:04:54.796 --> 00:04:58.316
and we're going to assume
that R2 is less than R1.

00:04:58.316 --> 00:04:59.265
We're essentially saying,

00:04:59.265 --> 00:05:01.731
what happens when interest rates go down.

00:05:01.731 --> 00:05:02.597
We already know.

00:05:02.597 --> 00:05:04.856
When interest rates go down,

00:05:04.856 --> 00:05:08.798
planned investment goes up.

00:05:08.798 --> 00:05:09.932
Everything else equal,

00:05:09.932 --> 00:05:11.933
if this thing shifts up,

00:05:11.933 --> 00:05:14.999
if this term right over
here goes from R ...

00:05:14.999 --> 00:05:18.149
if the input into it, if the
real interest rate goes down,

00:05:18.149 --> 00:05:21.332
then this whole expression
is going to go up

00:05:21.332 --> 00:05:23.423
and so you're going to have an increase.

00:05:23.423 --> 00:05:25.080
You're going to have a shifting up

00:05:25.080 --> 00:05:26.465
of your planned expenditure

00:05:26.465 --> 00:05:28.996
for any level of income.

00:05:28.996 --> 00:05:31.198
It might look something like this.

00:05:31.198 --> 00:05:34.079
It would look something like this.

00:05:34.079 --> 00:05:37.196
This delta right over here, this ...

00:05:37.196 --> 00:05:38.665
Let me do it right over here.

00:05:38.665 --> 00:05:40.398
This distance right over here

00:05:40.398 --> 00:05:44.263
is going to be your change
in planned investment.

00:05:44.263 --> 00:05:46.996
It went up because
interest rates went down.

00:05:46.996 --> 00:05:49.329
We saw that in the last video.

00:05:49.329 --> 00:05:51.931
We saw that we got to a new level,

00:05:51.931 --> 00:05:53.369
or we see now that

00:05:53.369 --> 00:05:54.743
when you shift that up,

00:05:54.743 --> 00:05:55.600
that investment goes up.

00:05:55.600 --> 00:05:57.200
Because real interest rate went down,

00:05:57.200 --> 00:05:59.684
you get to a new equilibrium point.

00:05:59.684 --> 00:06:02.768
That equilibrium point
is a higher level ...

00:06:02.768 --> 00:06:06.184
it's a higher level of GDP or income.

00:06:06.184 --> 00:06:08.101
We know from previous videos as well,

00:06:08.101 --> 00:06:10.133
that this distance right over here

00:06:10.133 --> 00:06:12.768
is the same as our multiplier

00:06:12.768 --> 00:06:15.599
times the amount that
things got bumped up.

00:06:15.599 --> 00:06:17.408
The amount that things got bumped up

00:06:17.408 --> 00:06:20.099
was the change in planned investment.

00:06:20.099 --> 00:06:22.532
Then, we multiply that
times our multiplier.

00:06:22.532 --> 00:06:24.684
Our multiplier is 1 over

00:06:24.684 --> 00:06:27.017
the marginal propensity to save,

00:06:27.017 --> 00:06:31.132
or 1 over 1- the marginal
propensity to consume.

00:06:31.132 --> 00:06:33.102
The marginal propensity to consume ...

00:06:33.102 --> 00:06:35.398
We assume it's going to be constant

00:06:35.398 --> 00:06:37.199
in order to even be able to do this map.

00:06:37.199 --> 00:06:39.266
That's this piece right over there.

00:06:39.266 --> 00:06:42.531
That is equal to our C1.

00:06:42.531 --> 00:06:44.266
The main theme here,

00:06:44.266 --> 00:06:48.017
the real big picture
here as we go on our way

00:06:48.017 --> 00:06:50.532
to constructing our ISLM model,

00:06:50.532 --> 00:06:52.266
is really that all we're seeing ...

00:06:52.266 --> 00:06:54.665
when real interest rates go up,

00:06:54.665 --> 00:06:56.278
planned investment goes down.

00:06:56.278 --> 00:06:57.696
When interest rates go down ...

00:06:57.696 --> 00:07:00.126
which is what we saw in this
example right over here.

00:07:00.126 --> 00:07:01.662
Actually, let me write this down.

00:07:01.662 --> 00:07:08.198
Y, planned expenditures 2 at
C as a function of Y - D +.

00:07:08.198 --> 00:07:11.778
Our new planned investment,
at this lower interest rate,

00:07:11.778 --> 00:07:13.817
+ G + net exports.

00:07:13.817 --> 00:07:17.454
This is our Y2 right over
here, our planned expenditures.

00:07:17.454 --> 00:07:18.788
We saw in this example,

00:07:18.788 --> 00:07:20.721
when real interest rates went down,

00:07:20.721 --> 00:07:23.192
planned expenditures ...

00:07:23.192 --> 00:07:24.691
When real interest rates went down,

00:07:24.691 --> 00:07:26.120
planned investment went up.

00:07:26.120 --> 00:07:29.387
That made total planned
expenditures go up.

00:07:29.387 --> 00:07:31.985
That made total GDP go up.

00:07:31.985 --> 00:07:34.054
Now we can have another relationship,

00:07:34.054 --> 00:07:36.190
which is really very analogous to this.

00:07:36.190 --> 00:07:38.941
Really, by changing this,
we're just shifting this curve.

00:07:38.941 --> 00:07:42.587
Then, you have the multiplier
effect on our equilibrium output.

00:07:42.587 --> 00:07:43.720
The big takeaway from here is,

00:07:43.720 --> 00:07:46.024
if real interest rates go up,

00:07:46.024 --> 00:07:49.121
not only does planned investment go down,

00:07:49.121 --> 00:07:51.690
that would shift this entire curve down.

00:07:51.690 --> 00:07:53.525
Then, that would also cause

00:07:53.525 --> 00:07:57.191
our equilibrium real GDP to go down.

00:07:57.191 --> 00:07:59.078
It would go down by some multiplier,

00:07:59.078 --> 00:08:01.501
by the multiplier of
how much this goes down.

00:08:01.501 --> 00:08:03.500
If real interest rates go down,

00:08:03.500 --> 00:08:04.999
then planned investment,

00:08:04.999 --> 00:08:06.388
because of what we saw in the last video,

00:08:06.388 --> 00:08:07.417
goes up.

00:08:07.417 --> 00:08:09.001
Then, that would cause ...

00:08:09.001 --> 00:08:09.986
That would cause this whole ...

00:08:09.986 --> 00:08:11.119
That's what we did in this video.

00:08:11.119 --> 00:08:12.720
This curve would shift up.

00:08:12.720 --> 00:08:13.916
If this curve shifts up,

00:08:13.916 --> 00:08:16.520
our equilibrium GDP is going to be

00:08:16.520 --> 00:08:20.084
however much this shifted,
times the multiplier,

00:08:20.084 --> 00:08:23.916
so your equilibrium GDP is going to go up.

00:08:23.916 --> 00:08:26.627
You really have a very
similar relationship

00:08:26.627 --> 00:08:28.916
in terms of just how things move.

00:08:28.916 --> 00:08:31.083
We can plot this.

00:08:31.083 --> 00:08:33.119
Economist are famous for

00:08:33.119 --> 00:08:35.707
not always plotting the
independent variable

00:08:35.707 --> 00:08:37.499
the way you would want to.

00:08:37.499 --> 00:08:38.787
As we construct our ...

00:08:38.787 --> 00:08:40.217
What we're going to see is our IS curve.

00:08:40.217 --> 00:08:42.467
It stands for investment savings.

00:08:42.467 --> 00:08:43.301
What we're going to do

00:08:43.301 --> 00:08:44.719
and we'll talk more
about that in the future.

00:08:44.719 --> 00:08:46.317
We plot the convention is to put

00:08:46.317 --> 00:08:48.986
real interest rates on the vertical axis

00:08:48.986 --> 00:08:53.217
and to put real GDP right over here.

00:08:53.217 --> 00:08:54.717
If you want to look at this relationship,

00:08:54.717 --> 00:08:56.918
when we have a high real interest rate,

00:08:56.918 --> 00:09:00.253
we're going to have a low real GDP.

00:09:00.253 --> 00:09:02.885
When we have a low real interest rate,

00:09:02.885 --> 00:09:04.253
we're going to have a high GDP.

00:09:04.253 --> 00:09:06.253
It's going to make spending go up.

00:09:06.253 --> 00:09:07.051
If spending goes up,

00:09:07.051 --> 00:09:08.156
you have a multiplier effect.

00:09:08.156 --> 00:09:10.127
It makes our equilibrium output go up.

00:09:10.127 --> 00:09:12.460
Low interest rate, high real GDP,

00:09:12.460 --> 00:09:15.125
so you have a curve that relates.

00:09:15.125 --> 00:09:18.031
If you want to relate real
GDP to real interest rates

00:09:18.031 --> 00:09:19.726
you get a curve like this,

00:09:19.726 --> 00:09:21.697
and it's called the IS curve.

00:09:21.697 --> 00:09:24.526
IS comes for investment savings.

00:09:24.526 --> 00:09:26.531
We're really more focused
on the I part of it,

00:09:26.531 --> 00:09:27.927
the way we analyzed here.

00:09:27.927 --> 00:09:30.364
The whole reason, based
on the logic in this video

00:09:30.364 --> 00:09:31.865
and the last one as well,

00:09:31.865 --> 00:09:33.994
the whole reason why we
have this relationship

00:09:33.994 --> 00:09:37.793
is due to real interest
rates impact on investment.

00:09:37.793 --> 00:09:39.326
When you have high real interest rates,

00:09:39.326 --> 00:09:41.031
you don't have much investment.

00:09:41.031 --> 00:09:45.531
Also, you'll be sapping out of GDP.

00:09:45.531 --> 00:09:47.125
If you lower interest rates,

00:09:47.125 --> 00:09:50.260
then that makes you end up
having a lot more investment,

00:09:50.260 --> 00:09:51.260
like we saw in the last video.

00:09:51.260 --> 00:09:53.793
That will expand GDP by the multiplier

00:09:53.793 --> 00:09:57.000
that we see right over there.