Dynamic model of tax transfers may see effective demand as an attractor state

A comment by Arne in a previous post raised the idea that a tax transfer from capital to labor would raise the effective demand limit. So a video was made using the dynamic model for the circular flow to test his idea. As it turns out, the model shows that the natural real GDP equilibrium level would rise… holding other variables constant.

(Click on title of post to open up post and see videos.)

The video says that the effective demand limit would rise. However, that statement was made too fast. We have to take into consideration other variables that would change too. For example, two other variables would not stay constant, namely capital’s marginal propensities to consume and invest. If capital had to pay a higher effective tax rate, they would invest a little less and consume at a lower rate. So the following video was made to show that small changes in those variables could bring the economy back to the original natural level of real GDP.

The natural level of real GDP is associated with the effective demand limit. Historic data show that the effective demand limit stays fairly constant through the business cycle. Here is a sample graphic to show the constancy of the effective demand limit. You can see adjustments that return to the trend line and eventually lead to the projected meeting place of real GDP and effective demand.

pot demand 5

So due to the constancy of the effective demand limit in setting a natural level for real GDP, the idea arises that the effective demand limit may be some sort of attractor state for macroeconomic adjustments. (An attractor state is a state to which a dynamic system will tend to return to.) If you were to change one variable, the other variables would adjust to maintain the dynamic equilibrium determined by the effective demand limit. The effective demand limit is based on a relationship that the combined utilization rates of capital and labor will not exceed an effective rate for labor share of income.

 

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