Explain the working of investment multiplier with the help of a numerrcal example.

[CBSE2005]
Or
Explain with the help of a numerical example how án increase in investment in an economy affects
its level of income.
CBSE 2005]
Ans. Investment multiplier may be defined as the rate of change in national income due to change in
investment. Thus,

Multiplier =angein National Income

Change in Investment
Multiplier is related to marginal propensity to consume (MPC).] Higher the MPC, higher will be
muliplier, Higher 4PCmeans-higher-eensumptien-which înduces producers to-produee-moere TEsulting n
increaseinincome. utltipirercoefficiemtisobratinettby foHewimgformuta allo r t l k t l t o H?S
4 t Heay dirtut K 1 1 MulHelier is
blu HPC AK. 1-MPC MPS Hisher lower ill
HeS Hol#uer
lahos
Tt Fa inverse relahoksLi 5[ HPS

AT4uadH (AY)
Ty (K)= FaI
yfgad (4

MAC1-MPC
Change i Feaje+
Chause in investment Snto me Con Sumtioh nta-m
3 3410F

Y A Y
Lworkig othe multilier_Ca be explaineel Loith he
help o efallowig ableAssUmphio thut AT=looo
MPL 08

Looo 00 0.8(loo ill

800 . 8 (8o0) 6o
640 08 (Yo)

Total 5 o00
n.

5000
lo00 -MPC 1-08 0o
341820 -

A 4T:looo 3t-
MPC 0:8 &\
 elAsSMAte
banks with the help of a numerical example.
creation by the commercial
Explain the process of money [CBSE Delhi 2011]

3TR-

HT TI LRR

H-T 374qem (1) r f i s H-10007. I (2) *y 3TRfYT TYTA 0.2 (3)

HT TUH5 THT 1000 . I H41 200 . fiTA 7 T e 800 .

5 5 T4T 1800. iT1 7 4 800. 1 20 TRTT 37Tq 160 7. f

Ans. Commercial banks create money through creation of credit. Commercial banks give more loans
than the cash deposits received from the depositors. The capacity of commercial banks to create credit

depends on following two factors aHOUht detoSited by h CostoHer ih t ha

ihit Amountof deposits. Meaw S
(i) Legal Reserve Ratio.
Legal reserve ratio requires the commercial banks to maintain a specified percentage of their deposits as
cash reserve. Lower the legal reserve ratio, higher will be the credit creation by commercial banks.

Total credit creation = Initial Deposit x - 1

Lega-Reserve Ratio
AUMbtion-
Working of money creation by the commercial banks
Rounds Deposits ans Reserves
Initial 1000 800 200
Ist Round 800 640 160
IInd Round 640 512 128

5000 4000 1000

Explanation; If a new deposit of 7 1000 is made in the bank. If the LRR is
banks keep only 20% of deposits as reserves. This implies that banks 20%, we assume that
keep only 200
of R 1000 and
lend the remaining 80% 7 800. Lending implies banks create new as reserve
-
ou
in the name
of borrowers. This is the Ist round creation and equals 80% of the initialdeposits of 800
Ind round, it
oreates new deposit of7 640 and lends 512 (80% of 640). Like this, creationdeposit. In the
of the further round will be 80% of in each
previous round. In each
respective round, the increase
smaller and smaller and
ultimately, it becomes zero. It is
DCeo
important to remember that the sum total oO
all deposits will ultimately be 7 5000 (Five times the initial deposit) i.e. 1000 5 { 5000.
x =
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he elohoHy ar youted hrou
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Hre 3O
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o 1

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HPS K
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O
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Q4. Explain the working of investment multiplier with the help of a numerical example.
[CBSE 2005]
Or
Explain with the help of a numerical example how an increase in investment in an economy affects
its level of income. [CBSE 2005]
Ans. Investment multiplier may be defined as the rate of change in national income due to change in
investment. Thus,
Multiplier=Change in National Income
Change in Investment
 98 U-LIKE Economics-XII
Muliplier is related to marginal propensity to consume (MPC). Higher the MPC, higher will
he
multiplier. Higher MPC means higher consumption which induces producers to produce more resulting in
increase in income. coefficient is obtained by following formula:
Multiplier
1
K-MPC MPS
Suppose, there is an increase in investment of 10,000 in the construction of a building. There will be
be
increase in the income of builder, architect and labourers of R 10,000. If MPC is 0.80, they will spend
T 8,000 (10.000 x 0.80) on consumption goods which will become the income of producers of ccnsumption
goods. The producers of consumption goods will again spend R 6,400 (8,000 x 0.80) which will become the
income of other people. This process will continue resulting in increase in national income. It may be shown as
under
Initial investment =Increase in income =
10,000
Step 2 =
10,000 x 0.80 = 8,000
Step 3 =
8,000x 0.80 7 6,400
Step 4 =
6,400 x 0.80 = 5,120
= T 4,096
Step5 5,120 x 0.800
Step 6 = x X

Total increase = 50,000

Multiplier= 50,000
10,000
5