Question

Discuss the mechanism of investment multiplier with the help of a numerical.

Answer 1

Investment multiplier is the number of times income rises due to a rise in the investment expenditure in the economy. It is represented as (K).

The working of the multiplier is based on the assumption that one man’s expenditure is another man’s income.

Suppose the government of the country spends ₹ 100 crores on the construction of a road, i.e., ΔI = ₹ 100. The first impact is that it increases the income of the workers engaged in the work by ₹ 100 crores.

Assuming MPC = 0.75, the workers will spend 75 crores, i.e., 0.75 × 100, on consumer goods. The producers of these goods will have an additional income of 75 crores. This additional income will be spent on goods, i.e., 0.75 × 75 = ₹ 56.25 crores.

This process will continue till the change in income becomes equal to multiple times the change in investment.

Hence,

Rounds	AI	AY	AC
I	100	100	75
II	-	75	56.25
III	-	56.25	42.18
	:	:	:
Total		400	300

K = `1/(1 - MPC)`

= `1/(1 - 0.75)`

= `1/0.25`

= 4

K = `(Delta Y)/(Delta I)`

`4 = (Delta Y)/100`

ΔY = 100 × 4

ΔY = ₹ 400

Additional income = ₹ 400