Scribd
Upload
1K views9 pages

Understanding the Economic Multiplier

The document discusses the economic concept of the multiplier. It states that the multiplier establishes a relationship between aggregate income and investment, where an increase in investment leads to an increase in income that is K times the initial investment increase. The value of K, or the multiplier, is determined by the marginal propensity to consume (MPC) - the higher the MPC, the higher the multiplier. The multiplier shows how an initial investment leads to further rounds of spending and income generation in an economy.

Uploaded by

srivastavasumita
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
1K views9 pages

Understanding the Economic Multiplier

The document discusses the economic concept of the multiplier. It states that the multiplier establishes a relationship between aggregate income and investment, where an increase in investment leads to an increase in income that is K times the initial investment increase. The value of K, or the multiplier, is determined by the marginal propensity to consume (MPC) - the higher the MPC, the higher the multiplier. The multiplier shows how an initial investment leads to further rounds of spending and income generation in an economy.

Uploaded by

srivastavasumita
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

The Concept of Multiplier

Unit 3

The Multiplier
(An Integral Part of General Theory of Employment)

The Multiplier establishes a precise relationship, given


the propensity to consume, between aggregate employment and income and the rate of investment.

It tells us that, when there is an increment of


investment, income will increase by an amount which is K times the increment of investment i.e. Y=K I

Investment Multiplier is the coefficient relating to an increment of investment to an increment of income i.e. K= Y/ I

The Multiplier
The value of the K is determined by the MPC. Higher the MPC, higher would be the value of K Y= c+ I Since c=cY Therefore, Y= cY+ I Y-cY= I Y(1-c)= I Y= I/(1-c) Y/ I=1/(1-c) Since, K=Y/ I K=1/(1-c) Since c is Marginal Propensity to Consume Hence, K=1/1-MPC Or K=1/MPS

Derivation of the Multiplier


C/Y (MPC) 0 1/2 2/3 3/4 4/5 8/9 9/10 1 S/Y (MPS) (1-MPC) 1 1/2 1/3 1/4 1/5 1/9 1/10 0 K (Multiplier Coefficient) 1 2 3 4 5 9 10

The table shows that the size of the multiplier varies directly with the MPC and inversely with MPS. Since the MPC is always greater than zero and less than one, the multiplier is always between one and infinity. If the multiplier is 1 it means that the whole increment of income is saved and nothing is spent because the MPC is 0. An infinite multiplier implies that MPC is equal to one and the entire increment of income is spent on consumption (it will lead to full employment in the economy and then creates a limitless inflationary spirala rare phenomenon)

Working of Multiplier
Works both forward and backward We take the sequence analysis which shows a motion picture of the process of income propagation. An increase in investment leads to increased production which creates income and expenditure. This process continues in dwindling series till no further increase in income and expenditure is possible. This is a large instantaneous process in a static framework, as explained by Keynes

Round

I (increment in investment) 100

Y (increment in income) 100 50 25 12.5

c=cY C=.5 50 25 12.5 6.25

S (Y-C) Increment in Saving 50 25 12.5 6.25

6.25 0
Finally 100 200

3.12 0
100

3.12 0
100

Assumptions of Multiplier
There is change in autonomous investment and that induced investment is absent MPC is constant Consumption is the function of current income No time lags in the multiplier process The new level of investment is maintained steadily for the completion of the multiplier process There is net increase in investment Consumer goods are available in response to effective demand for them Surplus capacities in consumer goods industries to meet the increased demand for consumer goods in response to a rise in income following increased investment Other resources of production are also easily available There is industrialist economy where multiplier operates Closed economy unaffected by foreign trade No changes in price Accelerator effect of consumption on investment is ignored Less than full employment level in the economy

Leakages of Multiplier
Saving Strong Liquidity Preference Purchase of old stocks & securities Debt cancellation Price inflation Net imports Undistributed profits Taxation Excess stock of consumption goods

You might also like