Question

Illustrate the working of the multiplier.

Explain the working of investment multiplier taking a numerical example.

Critically examine the working of investment multiplier.

Answer 1

1. Suppose the Government undertakes investment expenditure equal to ₹ 100 crores on some public works, by way of wages, price of materials, etc.
2. Thus income of labourers and suppliers of materials increases by ₹ 100 crores. Suppose the MPC is 0.8 that is 80 %.
3. A sum of ₹ 80 crores is spent on consumption (A sum of ₹ 20 Crores is saved).
4. As a result, suppliers of goods get an income of ₹ 80 crores.
5. They in turn spend ₹ 64 crores (80% of ₹ 80 crores).
6. In this manner consumption expenditure and an increase in income act in a chain-like manner.

The final result is ∆Y = `100 + 100 × 4/5 + 100 × [4/5]^2 + 100 × [4/5]^3`or,

∆Y = 100 + 100 × 0.8 + 100 × (0.8)² + 100 × (0.8)³

= 100 + 80 + 64 + 51.2…

= 500

That is `100 × 1/(1 - 4/5)`

= `100 × 1/(1/5)`

= 100 × 5

= ₹ 500 crores

For instance if C = 100 + 0.8Y, I = 100,

Then Y = 100 + 0.8Y + 100

0.2Y = 200

Y = `200/0.2`

= 1000 → Point B

If I is increased to 110, then

0.2Y = 210

Y = `210/0.2`

= 1050 → Point D

For a ₹10 increase in I, Y has increased by ₹ 50.

This is due to the multiplier effect.

At point A, Y = C = 500

C = 100 + 0.8 (500) = 500; S = 0

At point B, Y = 1000

C = 100 + 0.8 (1000) = 900; S = 100 = I

At point D, Y = 1050

C = 100 + 0.8 (1050) = 940; S = 110 = I

When I is increased by 10, Y increases by 50.

This is multiplier effect (K = 5)

K = `1/0.2`

K = 5