Balanced budget multiplier (BBM) is relevant only in a closed economy in which government expenditure and tax are the important tools in the working of BBM.
Mr Wllich in his article, “Multiplier effect of Balanced Budget” published in Economertrica explains very clearly that public expenditure covered by taxes had an income generating effect, independent of numerical value of MPC and MPS.
Working of BBM
He working of balanced budget or the process of income determination on under balanced budget can be discuss on the basis of income determination model of Keynes under C+I+G. In such a case we start first with some equilibrium level of income determined on the basis of consumption and increase in investment expenditure. After that we increase government expenditure but government expenditure is not covered by tax and then examines the impact on income and employment when government expenditure is covered by direct taxes.
Example: Let C= 25+0.75Y
On the basis of AD and AS approach, equilibrium level of income is Y= 25 + 0.75Y + 20=180
i.e. 80 crores.
If now government expenditure is increased by Rs. 25 and suppose government expenditure is not covered by tax, than the income will increase by simple multiplier times the government expenditure. It is proved as under:
Y= 25+0.75+20+25 Y-0.75Y=25+20+25
Y (1-0.75) = 70
Y=280 crores in Rs.
Foreign Trade Multiplier (Multiplier in Four Sectors Models)
The concept of foreign Trade multiplier, in an open economy, explains the estimated effect on country’s national income and employment due to excess of its exports over imports.
A country carrying foreign trade with another country may come to have excess of exports and imports. Income earned as a result of excess of exports over imports is like an injection in the income stream, and has the same multiplier effect on domestic income and employment as created by the initial increase in domestic Investment. The ratio of the final increase in income due to an initial increase in exports over imports is called foreign trade multiplier. Symbolically, Kf = ∆Y/∆X
The foreign trade multiplier also known as export multiplier operates like the investment multiplier of Keynes. It may be defined as the amount by which national income of a nation will be raised by a unit increase in domestic investment on exports. As exports increase there is an increase in the income of all persons associated with the exports industries. These in turn create demand for goods. But this is dependent upon their marginal propensity to save (MPS) and marginal propensity to import (MPM). The smaller these two propensities are, the larger will be the value of multiplier and vice versa.
In very simple terms we can say that foreign trade multiplier is a concept that states that net exports (exports minus imports) may magnify the impact on nation's income.