During a recession when GDP falls, disposable income _____.

CONCEPT: Disposable income is the income households have after taxes and transfers. Automatic stabilizers — a progressive tax system and transfer programmes such as unemployment benefits and welfare payments — act without any new policy decision: as national income (GDP) changes, tax liabilities and transfer payments move automatically to partly offset the change.

APPLICATION: In a recession, GDP contracts, so market incomes (wages, profits, rents) fall. But progressive taxation means average tax rates fall too as incomes drop into lower slabs, so tax collections shrink faster than income; at the same time, more households qualify for unemployment and welfare transfers, adding to household income. Both effects push in the same direction — they cushion the fall in post-tax, post-transfer disposable income relative to the fall in pre-tax GDP. So disposable income still falls, but by a smaller percentage than GDP does.

Cross-check against the alternatives:

• A rise in disposable income while GDP is contracting is inconsistent with wages, hours, and profits all being squeezed at once in a downturn.

• Disposable income staying perfectly constant would need stabilizers to fully insulate households from the shock — they do not; hours, profits, and asset incomes still fall even after taxes and transfers adjust.

• Disposable income collapsing to zero would mean a total halt of all income-generating activity — a recession is a slowdown, not a stoppage, so this does not occur.