Question

Why is the transfer multiplier smaller than the government expenditure multiplier?

Options

• Transfers are taxed at a higher rate than government purchases

• Government spending is spread over more sectors of the economy

• Direct government spending adds fully to demand, whereas transfers add only the consumed portion

• Transfers reduce the money supply while government spending increases it

Answer 1

Government expenditure of one unit enters aggregate demand entirely. Transfers only raise household income, of which only the fraction c is spent — the rest is saved. Hence the transfer multiplier \[\frac{c}{1-c}\] is smaller than \[\frac{1}{1-c}\].