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Transfer payments
Most governments also pay unemployment and welfare benefits.
Generally speaking, the number of unemployed people and those
on low incomes who are entitled to other benefits increases in a
recession and decreases in a boom.
This means that government expenditure increases automatically
in recessions and decreases automatically in a boomin absolute
terms. Since the trend of output is to increase in booms and
decrease in recessions, expenditure is expected to increase as a
share of income in recessions and decrease as a share of income
in booms.
Holding all other things constant, ceteris paribus, the greater the
level of taxes, or the greater the MPI then the value of this
multiplier will drop. For example, lets assume that:
→ MPC = 0.8
→T=0
→ MPI = 0.2
Here we have an economy with zero marginal taxes and zero
transfer payments. If these figures were substituted into the
multiplier formula, the resulting figure would be 2.5. This figure
would give us the instance where a (for instance) $1 billion change
in expenditure would lead to a $2.5 billion change in equilibrium
real GDP.
Lets now take an economy where there are positive
taxes (an increase from 0 to 0.2), while the MPC and
MPI remain the same:
→ MPC = 0.8
→ T = 0.2
→ MPI = 0.2
If these figures were now substituted into the multiplier formula, the
resulting figure would be 1.79. This figure would give us the
instance where, again, a $1 billion change in expenditure would
now lead to only a $1.79 billion change in equilibrium real GDP.
This example shows us how the multiplier is lessened by the
existence of an automatic stabiliser, and thus helping to lessen the
fluctuations in real GDP as a result from changes in expenditure.
Not only does this example work with changes in T, it would also
work by changing the MPI while holding MPC and T constant as
well.