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पाठ्यक्रम

Types of Multiplier

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Estimated time: 19 minutes
  • Types
  • Formula: Employment Multiplier
  • Employment Multiplier
  • Formula: Foreign Trade Multiplier
  • Foreign Trade Multiplier
  • Formula: Price Multiplier
  • Price Multiplier
  • Consumption Multiplier
  • Key Points: Types of Multiplier
CISCE: Class 12

Types

In Keynesian economics, the investment multiplier shows how an initial increase in investment leads to a larger increase in income. Apart from this, economists also talk about other multipliers:

  • Employment Multiplier
  • Foreign Trade Multiplier
  • Price Multiplier
  • Consumption Multiplier
CISCE: Class 12

Formula: Employment Multiplier

If:

  • N2 = primary employment
  • N = total employment
  • K′ = employment multiplier

Then:

\[N=K^{\prime}N_2\quad\Rightarrow\quad K^{\prime}=\frac{N}{N_2}\]

CISCE: Class 12

Employment Multiplier

Simple idea
Employment multiplier shows the relation between:

  • Primary employment: Jobs created directly by a new investment (for example, workers hired for road construction), and
  • Total employment: All jobs created in the whole economy due to that investment (direct + indirect/secondary jobs).

Kahn defined it as a coefficient that relates primary employment to total employment created by a given investment.

Real-life example 

  • Government invests ₹15 crores in road-building.
  • As a result, 2 lakh workers are employed directly in road-building.This is primary employment.
  • These workers then spend their wages on food, clothes, etc.
  • Because of this spending, business in consumption goods industries expands and more workers are hired there.
  • Suppose secondary employment created in consumption goods industries is 4 lakh workers.

Now:

  • Total employment  lakh + 4 lakh = 6 lakh workers
  • Primary employment  lakh

\[K^{\prime}=\frac{N}{N_2}=\frac{6}{2}=3\]

Meaning: For every 1 new worker employed in road-building, 2 more workers get employment in consumption goods industries.

Relation with investment multiplier 

  • If labour productivity is the same at all output levels, then employment multiplier K′ and investment multiplier K would be equal.
  • As output increases towards full employment, average productivity of labour falls, so K′ becomes larger than K.
  • If output is falling from full employment, employment multiplier K′ becomes smaller than the investment multiplier K.
CISCE: Class 12

Formula: Foreign Trade Multiplier

\[K=\frac{1}{I\times S}\]
Where:

  • K = foreign trade multiplier
  • I = marginal propensity to import
  • S = marginal propensity to save
CISCE: Class 12

Foreign Trade Multiplier

Simple idea
Some Keynesian economists, like Machlup, introduced the foreign trade multiplier. It explains how income from foreign trade (especially exports) leads to a multiple increase in income and employment in the home country.

  • When foreigners buy our goods, export industries earn more income.
  • Workers and firms in export industries spend this extra income on consumer goods.
  • This creates further rounds of income and employment inside the country.

Leakages
Foreign trade multiplier depends on two “leakages”:

  • Marginal propensity to save (S)
  • Marginal propensity to import (I)

Spending that is saved or spent on imports leaks out of the domestic income stream.

Example
If:
\[IS=\frac{1}{5}\]

Then:

So, if exports increase by ₹10 crores, the final increase in domestic income will be:
\[\Delta Y=K\times\Delta\mathrm{exports}=5\times10=\mathrm{र}50\mathrm{crores}\]

CISCE: Class 12

Formula: Price Multiplier

\[K_p=\frac{PL}{P}\]

Where:

  • Kp = price multiplier
  • PL = ultimate change in general price level
  • P = change in the price of the basic commodity
CISCE: Class 12

Price Multiplier

Simple idea

When the price of an important consumption good increases (for example, wheat), the rise is not limited to that good alone. Other prices also increase “in sympathy”, causing a multiple increase in the general price level.
This overall effect is captured by the price multiplier.

Real-life style example

  • Price of wheat increases from 100 to 102.
    Change in price of wheat = 102−100=2
  • Because of this, other prices also rise, and the general price level goes from 100 to 108.
    Change in general price level = 108−100=8

Now:
\[K_p=\frac{108-100}{102-100}=\frac{8}{2}=4\]

Meaning: A small initial price rise (here, 2 units in wheat price) leads to a 4 times larger change (8 units) in the overall price level.

Behaviour in developed vs underdeveloped countries 

  • In developed countries, the price multiplier usually starts working only after full employment is reached.

  • In underdeveloped countries, it starts earlier, and it can restrict the size of the income or investment multiplier because rising prices reduce the real effect of income increases.

The price multiplier therefore shows why it is important to control the initial rise in price of key commodities.

CISCE: Class 12

Consumption Multiplier

Simple idea

The consumption multiplier was introduced by Dr. P.R. Brahmanand and Prof. C.N. Vakil. It is based on the idea of disguised unemployment in underdeveloped countries.

  • In such economies, many people are engaged in agriculture but do not actually add to production.
  • This is called disguised unemployment.
  • According to Vakil and Brahmanand, there may be 25–30% disguised unemployment in the subsistence sector.

If these surplus people are removed from the land:

  • Total agricultural output does not fall, because they were not adding anything to production.
  • If they are given consumption goods (food, etc.) to live on, they can be employed in investment projects (roads, canals, factories).
  • In this way, output and investment can increase without reducing farm production.

Core idea

The consumption multiplier focuses on:

  • How an initial increase in the supply of consumption goods (like food) can cause a multiple increase in investment.

Vakil and Brahmanand clearly point out the difference between:

  • Keynesian multiplier: tells how much income will increase when investment increases.
  • Consumption multiplier: tells how much investment will increase when the supply of consumption goods increases.

Another way they put it:

  • Consumption multiplier tells: by how much consumption of goods must go down if a given increase in investment is to be self-financing.
  • Keynesian multiplier tells: by how much savings must go up if a given increase in investment is to be self-financing.

Real-life style interpretation

Think of extra people on farms in a poor country:

  • They consume food but do not add to output.
  • If these people are shifted to build roads, dams or factories, and are fed from the same food supply,
    agricultural production does not fall, but
    overall output and investment increase.

Thus, an initial increase (or release) of consumption goods supports multiple rounds of new investment and employment — that is the consumption multiplier.

CISCE: Class 12

Key Points: Types of Multiplier

  • Employment Multiplier: Shows how much total employment increases due to an initial increase in investment.
  • Foreign Trade Multiplier: Explains how exports raise national income through repeated spending.
  • Price Multiplier: A rise in price of one good leads to a multiple rise in overall price level.
  • Consumption Multiplier: Increase in consumption goods supply leads to multiple rise in investment, mainly relevant for underdeveloped economies.

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