Question

In an economy, if initial investments are increased by Rs 2000 crores, discuss the working
of investment multiplier presuming marginal propensity to save is 0-2.
Also explain the investment multiplier​

Answer 1

Explanation:

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment. For example investment is increased by 1,000 crore rupees, now

Particulars

Increase in Income

(Rs. Crores)

Change in Consumption

(Rs. Crores)

Change in Saving

(Rs. Crores)

Fist Round

1000

800

200

Second Round

800

640

160

Third Round

640

512

128

All other Rounds

2,560

2,048

512

Total

5,000

4,000

1,000

(a) In the multiplier process, increase in income in the first round is always equal to additional investment. So, Increase in income in the first round =Rs.1,000=Rs.1,000 crores.

(b) The saving off Rs. 200 crores indicates that increase in consumption will be Rs. 800 crores in the first round.

- additonal consumption of Rs. 800 crores out of an additional income of Rs. 1,000 indicates that 80% of income is spent, Le. MPC = 0.8. The values of second and third round are calculated on the basis of this data.

(c) Total Increase in Income = Additional Investment x kxk. In the given case:

Multiplier (k)=11−MPC=11−0.8=5(k)=11−MPC=11−0.8=5

So, Total Increase in Income =1,000×5=Rs.5,000 crores=1,000×5=Rs.5,000crores

(d) Total Increase in Consumption == Total increase in Income ×× MPC =5,000 x 0.8=Rs.4,000 crores=5,000x0.8=Rs.4,000crores.

(e) Total Increase in Saving == Total Increase in Income −− Total Increase in Consumption =5,000−4,000=1,000 crores=5,000−4,000=1,000crores.

(f) Values of All other Rounds' is calculated after subtracting the values of first, second and third round from the total increase in income, consumption and saving respectively.