Chapter Three

Multiplier and Accelerator Interaction

Concept of Induced and

Autonomous Investment:
A type of investment
which is governed by income and profit is
called as induced investment. This kind of
investment is guided by profit motive and
profit or income elastic. This kind of
investment is found in private sector
investment.
Induced Investment
Investment

Induced Investment:

Income/Profit

Investment

Autonomous Investment: A type of investment

which is independent of level of income or profit is
called as autonomous Investment. This type of
investment is income/profit inelastic and made by
government sector for economic development of the
economy.

Autonomous Investment

Income/Profit

Multiplier:

The concept of multiplier as employment multiplier was

initiated by R. F. Kahn in 1931 AD.

Concept of multiplier was further developed by
J.M.Keynes, which is Investment Multiplier.
Change in aggregate expenditure causes change in
equilibrium GDP or National Income/Output.
Often change in GDP is some multiple of change in
aggregate expenditure.
The factor by which GDP increases because of increase
in aggregate expenditure is called as Multiplier.
In simple two sector model, multiplier establishes a
relationship
between
increase
in
autonomous
investment
(I)
and
Increase
in
National
Income/Output(Y).

Mathematically,

Y
K
Where,
I
K =Multiplier

Y=Change in NI
I=Change in Investment
Hence, Multiplier is simply the ratio between
change in NI and change in autonomous
investment. As for example: if Investment
increase by 5 crores
Y and
15 NI increases by 15
K

3
crores. Then,
I
5
It means, output/NI will increased by 3 times when
there is increase in investment.

According to J.M.Keynes, Investment Multiplier tells us that

when there is an increment by an amount which is K times the
increment of investment.
Aggregate Expenditure

Kurihara, The multiplier is the ratio of change in income to the

change in investment.

Y
C+I+I
E1

C+I

E
I

Y1

NI/GDP

Relationship of Multiplier and

MPC:
We know that,Y C I

Y C I

Dividing both sides by Y, we get:

Y C I

Y Y Y
I
1 MPC
Y
I
1 MPC
Y
Y
1

I 1 MPC
1
1
K

1 MPC MPS

The above expression says that there exists

direct
relationship
between
MPC
and
Multipiler or Inverse relationship netween
MPS and Multiplier.
as for example:
If , MPC=o.2, K=1.25
MPC=0.5, K=2
MPC=0.75, K=4
MPC=0.9, K=10
Conccpt of Static and Dynamic Multiplier:
Concept of static multiplier implies that change in investment causes

change in income/output instantly.

Concept of Dynamic Multiplier recognizes the fact that change in income

is not instant process. There is a grdual process by which income changes

with change in investment in the economy.

Working Of Multiplier:
Let Us Assume an economy with MPC=0.5, i.e. K=2
IF Investment Increases by 100 crores then,
Rounds of
income
generation

Round 1

100

100

50

50

Round 2

50

25

25

Round 3

25

12.5

12.5

Round 4

12.5

6.25

6.25

All other
Rounds

12.5

6.25

6.25

Total

100

200

100

100

Backward Working of
Multiplier:
According

to the concept of multiplier, as a

decrease in initial investment there is several
times more decrease in national income/output. It
is called as backward working/reverse action of
multipler.

Suppose in an Economy, if Investment is decreased

by 10 crores and Multiplier is 2. then the national

income/output will decrease by 20 crores.
Hence multiplier works both in forward as well as

backward process.

Leakages of the Multiplier:

Idle Saving
Purchase of Old Shares and Securities
Paying of Old Debts
Import of goods
Inflation
Excess Stock of Consumption goods
Undistributed Profits
Taxation
High Liquidity Preference etc.

Importance of Multiplier:
To study the process of income propogation.
Justify the importance of Investment.
To Understand the Phases of Trade Cycle.
Explain the condition of Full employment.
Justify the significance of Deficit Financing.
Understand the need of equality of Saving and

Investment..etc

Super Multiplier:
The term Super Multiplier was coined by

J.R.Hicks in his business cycle theory.

He used the term to show the relationship
between change in induced investment and
corresponding change in income.
He proved that, induced investment makes the
value of investment multiplier larger.
In other words, Super Multiplier is the interaction
between multiplier and accelerator. Or, it explains
the combined effect of multiplier and accelerator
on equilibrium income, output and employment
of the economy.

Mathematically,K

I a

or , Y K s I a

Where,

Y= Change in income/output
Ia= Change in Autonomous Investment
Ks = Super Multiplier

Mathematical Derivation of Super Multilier can

be shown as following:

Let initial equilibrium income is divided into

consumption and investment.

Y=C+I or Y=C+Ia+Ii
When there is increase in investment, then
Y C I a I i

I i
C
Y
Y I a
Y
Y
Y
Y bY I a VY
Y bY VY I a
Y (1 b V ) I a
Y
1
1
Ks

I a 1 b V s V

Where, Ks=Super Multiplier

b = MPC
s=MPS
V= MPI or accelerator
coefficient

Let, Ia=Rs 10 million b=0.5 and V= 0.3 then

Ks= 5 which is much more than K=2.

Saving and Investment

Or, Y= 5 x 10=50 million.

Graphically,

S1
Ii
E3

E2

Ia

Ia

Y1

Y2

Y3

output

Signficance of Super Multiplier:

It

shows how an initial autonomous

investment leads to cumulative rise in
national income/output.
It proves the interdependency between
autonomous and induced investment.
It helps to explain the synamics of business
cycle more accurately.
It
justifies the importance of induced
investment over the autonomous investment.

Tax (subsidy) multiplier:

It is a type of fiscal multiplier.
It shows the effect of change in tax rate to the

national income/output.
Tax multiplier states that when there is
change in tax rate it will change the national
income/output in multiple times.
Same theory applies in case of subsidy also.
Therefore it is also called as subsidy multiplier.
The derivation of Tax multiplier can be
explained as following.

In a three sector economy,

Y=C+I+G..(1)
Where,
C=a+bYd
Y=Y-T
Then,
Y=a+b(Y-T)+I+G
Or, Y-bY=a-bT+I+G
Or, Y(1-b)=a-bT+I+G
1
a bT I G ...............( 2)
Y

Or,
1 b
When There is change in Tax rate then,
1
Y Y
a b(T T ) I G

1 b
1
a bT bT I G ..........(3)
Y Y
1 b

Substracting .(2) from .(3) we get,

bT
Y
1 b

Therefore,
Y
b

Tax Multiplier (Tm)=

1 b

Note:
A rise in tax (T) has a negative effect on the
equilibrium level of income/output.
A fall in tax (-T) has a positive impact on the
equilibrium level of income/output.

Foreign Trade Muliplier.

Foreign Trade multiplier can be derived in four

sector economy where export/import plays

vital role in national income/output.
Foreign Trade multiplier is in fact a ratio
between change in national income/output and
change in export.
Mathematically,
Y
Foreign Trade Multiplier (FTm)=
X
Where, Y=Change in national income/output
X=change in export

Mathematical derivation of foreign Trade

multiplier can be explained as following:
In four sector economy, equilibrium can be stated
as
Y=C+I+G+(X-M)..(1)
Where, C=a+bYd
Yd=Y-T
M=M+mY
YI and
a bG
(Y are
T ) constant.
I G X ( M mY )
Now, Y a bY bT I G X M mY
Y bY mY a bT I G X M
Y (1 b m) a bT I G X M
1
Y
(a bT I G X M ).............( 2)
1 b m

When exports increase by X, new equilibrium

becomes, 1
Y Y

(a bT I G X M X )

1 b m
1
1
Y Y
(a bT I G X M )
X ..............(3)
1 b m
1 b m

Substracting .(2)
from (3), we get.
1
Y

1 b m

Y
1

X 1 b m

Or, Foreign Trade Multiplier(FTm) =

Note:
If b=m, foreign trade multiplier is equal to unity.
If b>m, foreign trade multiplier is greater than

Accelerator Principle:
The concept of Accelerator was initiated by

J.M.Clark in 1917 AD.

Concept of accelerator was used to explain
the trade cycle by other economists like Hicks,
Samuelson, Harrod etc.
It is based on the fact that the demand for
capital goods is derived from the demand for
consumer goods.
Kurihara, The accelerator coefficient is the
ratio between induced investment and an
initial change in consumption.

Symbolically,

I
Acceleration coefficient (V)=
C
or , I VC

Where,

V=acceleration Coefficient
I=Change in investment
C=change in consumption
Later on, Hicks revised the concept of
acceleration coefficient as the ratio of induced
investment to change in income or output.
Thus, V I
Y
and it is also called as capital output ratio.

As for example: if the machine worth 5 lakhs produces

the output of 1 lakh then,

V=5/1=5
Equational Model of Acceleration Coefficient:
Gross Investment
(Igt)=V(Yt-Yt-1)+R
Igt = V Y+R(1)
Where, R-Replacement Investment
above equation shows that gross investment depends
on the change in output multiplied by acceleration
coefficient added with replacement investment.
Net Investment (Int)= V(Yt-Yt-1)
Or, I=V Y
I
Or,
V
Y

Working of Acceleration principle:

Period

0
1
2
3
4
5
6
7
8
9

Total
Capital
Replacemen
Output Required t Investment

200
200
210
230
260
280
290
280
260
250

400
400
420
460
520
560
580
560
520
500

40
40
40
40
40
40
40
40
40
40

Net
Investme
nt

Gross
Investme
nt

0
0
20
40
60
40
20
-20
-40
-20

40
40
60
80
100
80
60
20
0
20

Assumptions of Acceleration
Principle:
Capital output ratio remains constant.
Technology remains constant.
There should be elastic supply of cheap credit.
There is absence of time lags.
There is permanent change in consumption

demand.
There should be no excess capacity in the
capita goods industries etc.

Importance of Acceleration
Coefficient:
Acceleration Coefficient helps to understand

the process of income generation along with

multiplier.
Explains why the fluctuations in income and
output occur in the economy.
Explains that the capital goods industries
fluctuate more than the consumer goods
industries.
Helps to explain the upper turning point of
trade cycle.
Helps to explain the growth of the economy.

Criticism of acceleration
principle:
Invalid assumptions
Constant model(absence of dynamism)
Ignores the effect of price change.
Ignores the role of autonomous investment.
Only operates in the economy with full

capacity etc.

Thank You !