Effective Demand Research

Potential GDP reflects Labor Share... economic mystery revealed

I could have titled this post... "Potential GDP is as labor share does". The idea is that potential GDP and labor share reflect each other when compared to real GDP and capacity utilization respectively.

One thing people must realize is that potential GDP describes the center of the business cycle. (See video below for visual explanations.) It seems most people think potential means the top end of the business cycle, but they would be wrong.

Real GDP moves above and below potential GDP through the business cycle in a certain pattern. I will show in the video that capacity utilization moves the same way around effective labor share.

Equations for the video...

Blue line = Real GDP - potential GDP

Red line = Biz cycle amplitude constant * (capacity utilization - effective labor share)/effective labor share

Business cycle constant is displayed above graph in video. It will be changed to convert the % difference between capacity utilization and effective labor share into GDP billions of 2005 dollars.

Output gap = potential GDP - real GDP

The main idea to takeaway from this post is a big one...

Potential GDP is a reflection of how labor shares in the production of a country. If labor receives a larger share, potential GDP is higher. If labor receives a lower share, potential GDP is lower.

We can understand now why economists are just now figuring out that potential GDP is not so high as they thought, and that the output gap is not so high as they thought. They do not understand the effects of a lower labor share.

I am here to reveal the economic mysteries of labor share of national production.

Does raising taxes on capital and giving that money to labor raise the effective demand limit?

Here is a video in response to a question by Arne at the Angry Bear blog. He stated that if taxes were raised on capital and then that money was given to labor, that the effective demand limit would be raised.

This video says that he is correct and that the effective demand limit would rise. However, on second thought, the rise in capital taxes would lower the profit threshold of firms and lower the propensity to invest (MPI). So there could be offsetting consequences to nullifiy the effect on the effective demand limit.

 

I did another video to follow-up this one showing that as you raise taxes on capital, there will be offsetting changes in capital's propensity to consume and invest. These changes could offset the rise in taxes on capita, thereby bringing the equilibrium level of real GDP back to the effective demand limit.

This raises the question if the historic constancy of the effective demand limit is some sort of attractor state for the economy.

 

Link to original video explaining the dynamic circular flow model.

Video for Dynamic model of Circular Flow

Here is a video explaining the dynamic model of the circular flow for effective demand.