What is the effect of increasing or decreasing the number of states in markov chain process ?
The coefficients of the transition matrix gives the probability to change from a state to another. So if you add a state, first you will add a dimension, so yes, the transition matrix is changed. Then, as you add a state (and a state probably linked to other state) this will also modify the coefficient of the previous matrix.
If you are asking about the efficience of your algorithm, answer is yes too. Think about the algorithm of the k-means, used to cluster datas. If k, the number of groups, is too low, you won't see anything. If k is too big, you will see many uninteresting things.