[Music] okay so let's review what we were looking at here we were looking at the Keynesian model and we had something that kind of looked like this so we had our basically nominal GDP here I'm just gonna call it output and we had our aggregate expenditures here right we have our 45-degree line and we have some level of aggregate expenditures and at this level of aggregate expenditures we know that in the Keynesian model we're going to come up to an equilibrium where these aggregate expenditures are equal to output all right because if we're at an output level less than that and aggregate expenditures are greater than that then we're gonna have diss saving before at a point greater than that you're gonna have savings right so that in essence what's occurring in here and in output levels less than y1 here firms are going to see dis saving they're gonna see a decline in their inventory so that's gonna be a signal to them to start making more if we go beyond y1 they would see savings they would seen the Tories increasing that would be assigned to them to actually start making less now what we said was the problem was what happens if Y F is up here somewhere so how do we get to YF if we're at y1 because there's no reason for anybody to alter their behavior that's what the Keynesian model says we know that we're in a recession here at y1 but wages and prices are unlikely to fall in Keynes's mind are unlikely to fall and if they do fall it's in the long run not the short-run so he said well what we could in essence do is we need to find some way to increase aggregate demand up here to say 82 and we can do that by changing either some of these autonomous components or changing basically this marginal propensity to consume or the marsh propensity to import all right and like we said the easiest thing to do and by easy I mean relatively easy none of its stuff is easy it's all hard but some of its relatively easier to do than others is to change government spending right to an essence basically increased government spending or decreased government spending and consequently by that increased taxes or decreased taxes those are going to have the exact same result in terms of changing this aggregate expenditure so the interesting thing here though is that you don't actually need a large increase here so this guy right here and this guy right here this guy is smaller so here's our change in say aggregate expenditures and we're going to say that this is in essence a change in G and here is our change in income all right and what happens is that we get this change in government expenditures or this change in our aggregate expenditures can be anything I'm just using the change in government expenditures as though to create this larger change in an output right and we get this - what if something is called the multiplier effect all right so let's look at what this guy looks like let's assume we're just looking at consumption and output there's nothing else and let's assume that the marginal propensity to consume is 9 okay so here we are we're at some consumption we have some output here right if we have for example say a $100 increase in income what this guy says is that we're going to have some change here these around additional consumption we're gonna have some change here say 100 we don't know where this hundred dollars came from it just comes from somewhere and what this guy says is that people are gonna spend 90 percent of this right so what we see here is a consumption goes up by basically 90 you know here's what's interesting right we've got this additional $100 an income they're gonna go out I'm gonna spend $90 but when they're consuming these dollars that's somebody else's income all right so then $90 that they spend on haircuts and movie tickets and food well that's how the barber and the guy that works at the movie theater and the farmer earn income right you're buying their food you're buying their movie tickets and you're buying their haircut so in essence their income has gone up by 90 now if the barbers income has gone up by 90 and he spends 90 his consumptions gonna go up all right say 81 and so he spends his 81 dollars on I mean whatever could be I don't know kitchen cabinets right so now he spent eighty one dollars on kitchen cabinets but the money that he's spending on his kitchen cabinets to him to the barber is consumption but to the guy that makes kitchen cabinets it's income that comes down here is B 81 right so now the kitchen cabinet guy has seen his income grow by 81 dollars and he spends 90 percent so he'll spend basically 73 and there's obviously period such and such and such try but we don't want to get into all that so he's kind of the kitchen cabinet guy spins $73 fixing his car all right so he's consuming he's buying this his car getting fixed up but to the guy at fixing up his car the $73 is in consumption its income all right so now the guy that has his car fixed he's gonna spend ninety cents or 90 percent of his income right so he's gonna spend $65 on hiring somebody to trim his trees right so the $65 that he's spending on somebody hiring somebody to trim his trees to the guy that does cars that's consumption but to the guy that trims trees that's his income and on and on and on down we go right and interestingly enough when you add all this up you're going to see here that income has grown by in this example a thousand this one hundred plus this 90 plus 81 plus the 70 plus the 65 plus 59 all the way down till we get down to zero we've seen income grow by a thousand but of course this means we will see an additional consumption grow by 900 all right so we have this multiplier that tells us how much a change in these aggregate expenditures is going to change output and you can see it in a couple different ways I mean you can see it is this let's assume let's ignore the import stuff let's just look at the consumption part here's our output here's our aggregate expenditures here's our 45-degree line here's 180 line call this y1 and we'll have some corresponding change here AE - why - so here's the change in aggregate expenditures here's the change in output this guy right here is smaller than this guy but if we make this guy steeper right if we make this aggregate expenditure line steeper let's have the exact same thing here 81 82 I'll call this a y3 I'll call this guy say why for it's the same change here but we have a bunch of larger change in income all right depends upon the slope of this marginal propensity to consume we know that income is our C plus I plus G Plus X minus M right and we know what C is C was a plus B Y we know what I is I was I oh we know what G is G was G oh we know what X is X was X so we know what M is M was caught a little M plus M one right I'll just call it like a little bulb are there or whatever could be anything all you got to do is plug and chug plugging the numbers check out the answer I know that this is occurring we've taken these guys right here and just plug them into here I know all we got to do is get like terms together all right so we've got our Y here a plus IO + g o plus X zero minus M right - is in bar y plus B Y all right but these guys can come over here Y plus M Y minus B y equals a plus IO plus G Oh this X Oh - and remember M here is autonomous imports this little m bar right here is our March propensity to import you factor out the Y and / this guy right here so we see that output here is equal to our autonomous consumption + io + geo plus x0 minus M this autonomous level of imports divided by 1 plus M minus B all right but remember the MPs and the NPC are equal to 1 so the negative of negative B is the Marg propensity to import or to us to save I mean strike that nice should be negative strike that so we've got these autonomous components here when we can change any of those guys its easiest to change G but we want to know well what's there going to be the size of that multiplier you don't have to know all the algebra but you do not have to know the multiplier right so that you see here that for every single one of these changes right if our marginal propensity to consume is 0.9 and looks like I said let's ignore the marginal pencil ad to import let's assume it's equal to zero it's 1 over 1 minus 0.9 that's 1 over 0.1 well 1 or 0.1 is 10 every single dollar that you change here gets you a $10 change as opposed to say if the miners repent City to consume was say 0.5 should be to write every single dollar that you change here bless you brings in two more dollars so what this guy says is that if we know these numbers if we know this guy if we know this guy this guy this guy this guy we know this and this you can set this guy right here G to be any number that you want it to be to make Y be any number that you want it to be so that if you know oh look the March propensity to consume is 0.5 oh look the marginal propensity to consume is 0.9 and I want to get here to say Y 4 I want to get to any noise it can be any number that you want to get to seems blue if I'm here on this line right here this aggregate expenditure line with this marginal Penn City to consume equal to 0.5 and I want to get up here to 0.4 I can know exactly how much a change in these aggregate expenditures I need to have to get to that point in other words what Keynes is saying is that we can micromanage the economy in such a way that if we know these numbers are Marsh propensity to consume are appended to import the amount of investment in exports and all this other kind of stuff you can be anywhere there's no reason to ever have a recession again if you have a recession you just change government spending or you change taxes or you get people to change investment or you get exports to change or you get a to change or whatever you just do it the problem is it's harder to do those things so it's easier to change G so he says just change G if the economy is doing the exact opposite if it's too high you just cut G so if we're at this point right here here's our output here's our expenditures here's our 45-degree line if we're here we're at 81 or at y1 and we want to be here we want to be at YF here's the full employment level of output well you just decrease government spending right or increase taxes by some amount this amount whatever it is here Delta G and you can get this Delta Y to get you to YF the full employment level about but you can just set it like you would your microwave you just set the clock to B or whatever it is that you want it to be now from a practical political standpoint is it easy to cut government spending No all right and that was one of his in my opinion one of his big mistakes because he says well look we can just change government spending to get to this level of output that we want to it's easy to spend more money and give people stuff it's hard to take stuff away to say well we don't really have we need to decrease government spending no more no more subsidizing higher education you guys pay the full cost now alright so not whatever was Missouri State charge two hundred bucks an hour is that right so what you guys pay the reason you pay two hundred bucks and is that what it is I don't know what it is 130 I don't remember hundred you guys don't even know do it's assumed it's a hundred it's a hundred and that's a hundred dollars an hour it doesn't really cost a hundred dollars an hour it costs like four hundred bucks an hour alright and the other three hundred bucks are being subsidized by the state just change G so let's assume they just said ah screw it we don't really have the money we want to make the economy not be a y1 we want to be at YF we're gonna cut G no more hundred bucks and hours for MSU students now they're gonna pay 350 an hour how would that go over yeah exactly right I mean in essence this is what would happen right no more spending on Medicaid no more highways no more whatever all right people aren't gonna go for that it's easy to do this it's really really hard to do that all right so from that aspect he's his model it works well algebraically but from a practical political standpoint once you get that increased government spending you you just can't get rid of it so it's easy to increase gee it's really really hard to cut you so let's look at his model in a couple of different ways remember he's a demand driven guy so here's our output and our 45 degree line here's I have your expenditures May 1 let's assume this is just some number this is whatever number we want it to be 14 trillion and the full employment level of output is here it sets a 18 trillion so we know that we can do this AE to right we know that this guy's our full employment level of output YF here's one one oh we just have some change here and these aggregate expenditures all right anyone hey E - why stop there why not go beyond it why not have thirty trillion my stop at 18 we can set the economy to be anything that we want it could be why stop at 18 trillion why not make a 30 trillion dollars exactly you got inflation right there is no long-run aggregate supply curve in this model we're taking the long-run aggregate supply curve from the atas model and we're going to take it out and we're gonna paste it into the Keynesian model remember the LRA s here is a real this is from the aggregate demand aggregate supply model remember output here and the Keynesian model was nominal so you can have 30 trillion dollars in output if you want to but in real amounts of output what do you have 18 trillion it hasn't changed right you're essentially at this guy right here so when you go this way you've got inflation but no one employment when you go this way you've got unemployment but no inflation and you can take the Keynesian idea let's take Keynes's model and stick it in the a das model just like we took part of the a das model and stuck in the Keynesian model let's take the Keynesian model and stick it in the a das just for comparison so here is our real output here's our price index so if all of the assumptions of the Keynesian model are correct and we take those assumptions and we look at them through the atas model we're gonna have a short-run aggregate supply curve that looks like this and we'll have our long-run aggregate supply curve that goes right here and then we've got these changes here in aggregate demand so here's a t1 there's a t2 here's a t3 y1 y2 y3 right and we can have these changes in aggregate demand if we're at some output levels say y1 what kane says is hey we need to find a way to increase aggregate demand we need to find a way to change squared we're gonna call it fiscal policy here in about 10 minutes we're going to have these changes in fiscal policy we're going to change government spending or taxes to make aggregate demand increase and we can make it increase to this and we can make it increase to that we can make it increase from 81 all the way up here to 83 and we'll see no change in the price Index inflation won't exist at all til we get up to y3 and then if we have additional changes in aggregate demand when won't get any increases in real output we'll just get the price index so maybe here it was 210 and here it's you know 240 or whatever and this change and the price index means that there is inflation that's what the price index tells changes in the price index tell you rates of inflation now the problem is and this is where we've gotten away from the Keynesian model is that this model in essence says you can't have both inflation and unemployment at the same time and clearly we've had uninflated and unemployment at the same time we had that during the 70s so people were all atas models horrible blah blah blah we got the Keynes and model fixed out we can essentially mathematically get to whatever level it is that we want to be and then they're fine with that for a while then the 70s come along and they're like color crop Keynesian model says this can't exist Keynesian model must not be perfectly right either so in short we don't know what models right when it comes to the macro economy we really don't and people that say that they do know are lying they are simply wrong we simply do not know your micro book your principles of micro book if you're taking principles of micro you could get a book from 1905 the material has not changed right cost is a cost revenue is a revenue a price is a price all that stuff is hasn't changed macro this stuff changes all the time it just does so we have different models and different models explain different things in different parts okay but some things they don't explain very well so we kind of have this kind of hybridization and that's why you have all of these arguments about cutting taxes or not cutting taxes or increasing government spending or not increasing government spending or I don't know I mean all the stuff that we're arguing about today all right it's all relate because kind of don't really know which model to use so we're looking at these changes here in aggregate demand and like we said the easiest way to do this is through changes in G and we've got basically two different types of policies that can lead to these changes the first one is called fiscal policy where we're looking at changes and taxes or spending by governments the other one is monetary policy where you're looking at changes and the money supply and the key here for monetary policy that your changes you're changing interest rates and by changing interest rates you change consumption and investment right if the interest rates 12% you're less likely to go out and buy a car than if the interest rate is 3% if the interest rate to borrow is 12% IBM is less likely to build the new factoring than if the interest rates 3% so monetary policy can change the economy through essentially changes in consumption and investment and to a smaller degree changes in government spending physical policy says let's look at these changes in taxes and spending right because here you're looking at changes in G and to a degree by changing taxes you can change this guy because we can make Y here not just income but we can make him income minus taxes we can make him after-tax income all right we can always make the models more realistic if we want to but they always become more complicated because now it's this guy all right now plug all that stuff back in and run all through and then you can include taxes on here if you want to so we can change after-tax income changing taxes or we can change government spending will change in after-tax income is going to change consumption all right changing marginal tax rates might change I once again we've assumed here in this model that it's autonomous once you move on to like intermediate macro you don't make that assumption anymore this is just a simplifying assumption both of these guys are simplifying assumptions actually all of these guys are we can always make these guys more realistic and they are and the other models much more complicated right so let's look at this idea of fiscal policy we're gonna start off with it and we're gonna start off with the discussion basically a taxes we've got a couple of different principals here that we're interested in the benefit principle says people should be taxed you know pay these taxes based upon the benefits you receive alright where is this ability to pay principle says people should pay taxes based upon their income levels now they don't sound that different but there are vastly different ideas because in essence with the ability to pay principle says is that you can think of it like this people that earn more income should pay more taxes does that seem fair yeah sure the benefit principle says receive a benefit pay for it does that seem fair yeah there's two income levels they're both receiving $5,000 in benefit national defense everybody receives the exact same amount of national defense what do you think take this out of government pay for stuff based upon the stuff you get should people get soda without paying for it does that seem fair cars houses food quiet so if they're getting $5,000 worth of benefit from national defense and they make ten thousand dollars worth of income they should pay five thousand dollars in taxes right there's the ability to pay principal we're gonna take this the rich guy is gonna pay all of it the poor guy pays nothing that's fine except that now this guy's what we actually have a word for it he's a free rider so which do you choose what type of question is this normative or positive it's a normative issue because if you earn more income do you have more ability to pay taxes yes okay this sounds pretty good should people get stuff without paying for it okay this one sounds good so what do we do $5,000 for both or $10,000 for this guy ken are there people here who think this is unfair are there people I agree there's at least one person here that thinks this is unfair I'm telling you that there is you're just not willing to raise your hand are there people here who think this is unfair totally so which is fair it's a normative issue you cannot discern you cannot determine which is fair and here's what's really really interesting the only way to make the tax system fair by any metric that you want to use ability to pay benefit principle any principle that you use is if two conditions are met everyone has identical income everyone has identical preferences if both of those conditions are true then you can devise a tax system that is fair right because if everyone has the same income but different preferences I want these many fire stations no we don't need that many fire stations we need this number of fire stations I want this level of national defense no no we don't need that level of national defense we need this level of national defense identical income right a household of two people and a household of two people you can even make these households the same there's a mom and a kid here's old guy old lady I want lots of spending for K through 12 education because my kids in K through 12 I don't want that I don't have any kids in K through 12 quit taxing me for these kids I'm not gonna be alive to see them grow up and do crap old people hate property taxes do you know why because it funds schools and they don't want to fund schools they don't have kids they're like why should I pay for this one person's got a hundred thousand dollars one person's got ten thousand dollars whichever way you do it you're going to have a problem so how often do we have a situation where everyone has identical income and everyone has identical preferences never it never happens so what is the probability of devising a tax system that is fair to everybody it's zero it's completely zero all right we'll pick out from here