Automatic Stabilizer - Automatic Stabilizers Incorporated Into The Expenditure Multiplier

Automatic Stabilizers Incorporated Into The Expenditure Multiplier

This section incorporates automatic stabilization into a broadly Keynesian multiplier model.

• MPC = Marginal propensity to consume
• T = Induced taxes
• MPI = Marginal Propensity to Import

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.

There is broad consensus among economists that the automatic stabilizers often exist and function in the short term.

Additionally, imports often tend to decrease in a recession, meaning more of the national income is spent at home rather than abroad. This also helps stabilize the economy.