I took the circular flow model from the previous post and I tested it for current conditions.

Conditions for national accounts and other numbers are currently...

- Real GDP of $15.650 trillion. (2009 dollars)
- Effective demand limit of $16.1 trillion. (real 2009 dollars)
- Effective labor share of 74%. (Effective labor share is a value determined from the relationship of labor share and capital utilization.)
- Consumption $10.700 to $10.750 trillion.
- Government expenditures $2.900 trillion.
- Real gross private domestic investment $2.520 trillion.
- Real net exports -($450 billion) annual basis.
- Real exports $2.000 trillion.
- Real imports $2.450 trillion.
- Gross government borrowing $500 to $600 billion.

Assumptions are...

- Net taxes (taxes - transfers) are 15% for both labor and capital.
- All autonomous spending has been made to equal zero. Marginal propensities are for each dollar of disposable income.

Constraints of the circular flow model. These constraints are run in the Solver function of excel.

- Imports are roughly the same percentage for both labor and capital consumption. Imports for capital were set at 20% of capital disposable income, (capital income - capital net taxes).
- Capital saving is equal to gross undistributed corporate profits of $1.0 trillion.
- Saving is the money left over from income after taking out net taxes, consumption and imports.

The solver function asks for a target value.

- Target value is setting GDP $56 billion greater than GDI. GDI is out-going income from firms. GDP is in-coming expenditures to firms from the economy. $56 billion was chosen because this value allows real GDP to increase until the equilibrium level of $16.1 trillion at the effective demand limit. GDI and GDP will be equal at the effective demand limit. GDP can be greater than GDI, because more money can be injected into firms in various ways. But it is difficult for GDI (out-going) to be more than GDP (in-coming), because that means firms are paying out more income than they received. This is another way to see the effective demand limit.

Solver asks for numbers to change in order to meet the target value. Numbers to change are highlighted with yellow...

- Marginal propensity to consume for labor.
- Marginal propensity to consume for capital.
- Marginal propensity to import for labor.
- Marginal propensity to import for capital.
- Marginal propensity to invest.

When all these parameters are entered into solver, solver returns this result.

Graph #1

The Marginal propensities to consume for labor and capital are the primary results from the solver function. These MPCs satisfy the parameters given above. We see that labor spends 88 cents of every dollar of disposable income (income after net taxes). Of course, some labor spends more, some less. Capital income spends 59 cents of every dollar of its disposable income. The capital consumption assumes the saving of $1 trillion undistributed corporate profits. If overall capital saving is above undistributed corporate profits, consumption would be lower. If capital saving is below it, consumption would be higher.

The marginal propensities to import were based on making imports roughly 20% of disposable income.

The marginal propensity to invest results to be 16.1%. Thus, there is investment of 16 cents for every dollar of real GDP.

## Taking it to the effective demand limit

We can see in the above graph that in-coming GDP at the bottom is greater than the out-going GDI at the top. If we take that GDP at the bottom and then put it as out-going GDI at the top, the GDP at the bottom would progressively increase. If we kept doing that, eventually GDI would equal GDP. The place where they equal is the effective demand limit. At this limit, out-going cannot be greater than in-coming.

I will solve for the effective demand limit using the goal seek function in excel. I simply state that I want GDI and GDP to be equal, then I ask goal seek to change GDI. The GDI that results gives the equilibrium point of the economy in terms of real GDP.

Here is the result.

Graph #2

No changes to the marginal propensities. The numbers just grew together within the parameters. But it is interesting to note that as the economy grows within set parameters, an equilibrium point will be reached. There are various ways to determine this point in order to double-check the result.

## And if we raised labor share?

If effective labor share was somehow raised to 76%, what would happen to the equilibrium point of real GDP?

Graph #3

All I did was change effective labor share from 74% to 76%, then solved for equilibrium GDP. As we can see, the equilibrium of GDP rose to $16.558 trillion. That is over $400 billion more in output, which is still less than full-employment as determined by the CBO estimation of potential real GDP.

It must be said that labor share must rise on a consistent basis for this change to take place, because the income has to circulate through the economy for many quarters. If labor share rose one quarter like 4th quarter 2012, then fell, the equilibrium level of GDP would not change. But hey, if effective labor share rose just a little, that's a few more people that could be employed, even though it's not full-employment.

And the main reason to raise labor share is because GDP equilibrium is not below full-employment.

The marginal propensities did not change in graph #3. But would they change as the economy got closer and closer to the GDP equilibrium? That is a question to watch over time.

You will see that net exports is changing. That is because exports are being held constant, due to the fact that foreign markets determine demand.

Note: These are preliminary numbers that need to be refined. For example, what really is the net saving of capital income? What really is the marginal propensity to import for capital income? Answering just these two questions would allow us to be exact with the marginal propensity to consume for labor and capital.

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