Question

Assuming that 'increase' in investment is Rs 900 crore and marginal propensity to consume
is 0.6. explain the working of the multiplier.

Answer 1

Given that

Value of MPC = 0.6

An initial increase in investment = Rs 900 crore

So, every increase of Re 1 in the income, 0.6 part of the increased income will be consumed by people.

Consumption= Rs 0.60

Saving= Rs 0.40

Round	Increase in investment ΔI	Change in income ΔY	Induced change in consumption ΔC	Savings ΔS
1	900	900	540	360
2		540	324	216
3		324	194.4	129.6
4		194.4	116.64	77.76
5		116.64	69.98	46.66
6		69.98	41.99	27.99
7		41.99	25.19	16.8
8		25.19	15.11	10.08
9		15.11	9.06	6.05
10		9.06	5.44	3.62
11		5.44	3.26	2.18
12		3.26	1.95	1.31
13		1.95	1.17	0.78
14		1.17	0.7	0.47
15		0.7	0.42	0.28
	Total	2,250	1,350	900

The above shows the process multiplier which continues and the income will increase due to increase in consumption.

Changes in the income (AY)= Rs 2,25

Change in the investment (Al)= Rs 900

`k = 1/(1-MPC) = (ΔY)/(ΔI)`

`k = 1/(1- 0.6) = (ΔY)/900`

`1/0.4 = (ΔY)/900`

`ΔY = 2250`

Hence, an initial increase in the investment by 900 crore lead to an increase in income and output by its 2,250 crore.