What is the likely magnitude of The multiplier

Authors Avatar

What is the likely magnitude of The multiplier

The model, though, needs to be expanded if it is to be of any use. It currently lacks the impact of government and foreign trade.

Firstly, the impact of government will be considered. Government spending is a form of investment, and thus is incorporated into the formula as G:

Y=C+I+G.

Personal disposable income is the income households have after transfer payments from government and taxation to government has been accounted for. Transfer payments are included in net taxation, T. Thus, the consumption function must take account of the loss due to tax:

C=A+b(Y-T)

In the model, it is assumed that net taxes, T, are proportional to national income. The net tax rate is t, so the total revenue from net taxes is T=tY.

If the net tax rate is 15% of national income, then if Y is increased by one unit of currency, net tax revenue will raise by 15% of this increase.

Join now!

Disposable aggregate income (YD) will thus be:

YD=Y-T.

As Y-T=Y-tY, YD must equal Y(1-t). Thus, for each unit of income, households only keep (1-t) . If t=15%, households will have access to only 85% of the pre-tax income (1-0.15).

As a result, the multiplier becomes:

1/[1-b(1-t)].

This is because the loss of income due to taxation has to be taken account of. The consumption function pivots to reflect the reduced MPC. This causes the equilibrium to change to a lower level as the point where it crosses the 45° would be less. Reducing taxes or increasing transfer payments ...

This is a preview of the whole essay