Government Expenditure Multiplier of National Income

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Let us learn about Government Expenditure Multiplier of National Income.

Like private investment, an increase in government spending results in an increase in national income. This suggests that its effect on national income is expansionary. As we have shown earlier that there is a limit to private investment. Thus, to stimulate income the gap has to be filled up by government expenditure.

However, the increase in income will be greater than the increase in government spending. The impact of a change in income following a change in government spending is called government expenditure multiplier, symbolized by K_G. The government expenditure multiplier is, thus, the ratio of change in income (∆Y) to a change in government spending (∆G).

Thus,

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K_G = ∆Y/∆G

and ∆Y = K_G. ∆G

In other words, an autonomous increase in government spending generates a multiple expansion of income. How much income would expand depends on the value of MPC or its reciprocal, the MPS.

The formula for K_G is the same as the simple investment multiplier, represented by K_I. Its formula (i.e., K_G) is:

The impact of a change in government spending is illustrated graphically in Fig. 10.19 where C + I̅ + G̅₁is the initial aggregate demand schedule. E₁ is the initial equilibrium point and the corresponding level of income is, thus, OY₁. If the government plans to spend more, aggregate demand schedule would then shift to C + I̅ + G̅₂.

Fig. 10.19: The Government Expenditure Multiplier

As this line cuts the 45° line at E₂, the new equilibrium level of income thus rises to OY₂— an amount larger than the volume of government expenditure. It is clear from the Fig. 10.19 that increase in income (∆ Y) is larger than the increase in government spending (∆G).

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The reason behind this expansionary effect of government spending on income is that the increase in public expenditure constitutes an increase in income, thereby triggering successive increases in consumption, which also constitutes increase in income. However, greater the MPC, greater will be the increase in income.