MULTIPLIER

 Keynes says that the level of NI is determined by the level of

aggregate saving and aggregate investment.
 When the investment level increases, the NI increases due to
which the amount of consumption increases but the increase
in the consumption level is less than the increase in income.
 Thereby, saving increases in order to become equal to the
increased level of invest and reverse would be the situation in
case of a fall in the investment level.

MULTIPLIER:
 “The ratio of change in national income to a change in investment”.

K=
  
 The above method is a straightforward way of defining the concept of the
multiplier. Another way to put it would be :
MPS =

MULTIPLIER
 MPS =
=
K=
  
 Since [Y = C + S, Y + C + I / S – I or =

Therefore, K =
 Since K =
And that, MPS = 1 – MPC
Therefore, K =
  
Applying the formula, supposing that MPC = 0.9 and MPS = 0.1, thus,
K = = = 10
Or K = = = 10
 With an investment of Rs.100 billion, the investors purchase (say) machines and raw
material.
 This would increase the income of the sellers of the capital goods by Rs.100 billion.
 Assuming that MPC is 0.9 or 90% and MPS is 0.1 or 10%.
 The sellers will divide the income into two parts.
 90 billion rupees are spent on consumer goods and 10% is saved.
 The Rs.90 billion spent on consumer goods by the sellers become the income of the
sellers of the consumer goods who in turn divide the income of Rs.90 billion in two
parts.
 Thus, such a process continues till NI increases……

THE MULTIPLIER PROCESS:

 The economy is assumed to be a closed economy i.e. the economy is not open
to the world for trade relations.
 No leakages from the “income stream” take place.
 The is no change in the pattern of income distribution.
 The MPC remains constant.
 There is no time-lag involved between income and consumption; whatever is
earned is immediately consumed.
 Induced investment is not included in the analysis of the multiplier. In this
theory the change in investment refers to a change in autonomous investment.

ASSUMPTION OF THE MULTIPLIER

THEORY
DIAGRAMMATIC
REPRESENTATION
OF INVESTMENT MULTIPLIER
 1. Leakages:
Different leakages from a series of consumption reduce the extent to which income
should increase by the force of the multiplier.
i. Paying their old debts.
ii. Part of the income leaks out due to inflation.
iii. With an increase in govt expenditure, there is an adverse effect on the investment
in the private sector. It may reduce income to the same multiple extent. Thus, there
is no net effect on the NI.
iv. Hoarded money is considered as a temporary leakage.
v. In the real life, all the economies are open. Expenditure on imports is a leakage.

LIMITATIONS OF THE MULTIPLIER

THEORY:
2. Change in the MPC :
The multiplier theory is based on the assumption that the MPC remains
constant within the short run. However, practically it may change in the
short run.
3. Continuous increase in investment:
There should be a continuous increase in the level investment as it is
required to maintain the increased level of saving and investment so as
to have a multiple increase in the NI. However, if the level of additional
investment is not maintained NI would fall down to the previous level.
4. Time Lag:
The multiplier theory explains that there will be a spontaneous
increase in the NI as a result of an increase in investment. However, in
reality this is not so.
 Time involved in production and then distribution and creating demand for goods and services.