Question

Suppose for an economy, government proposes project for construction of expressways with an incremental investment of ₹ 1200 crore. Assuming, 80% of increase in income is spent on consumption. Estimate the following on the basis of above information:

1. Change in income (ΔY). [2]
2. Change in consumption (ΔС). [2]

Answer 1

(a) To measure the changes in income (ΔY) and consumption (ΔC) for the given economy, we’ll use the investment multiplier (K) concept based on the marginal propensity to consume (MPC).

Given Information in the question:

Incremental investment (ΔI): ₹ 1200 crore

Marginal Propensity to Consume (MPC): 80% of income is spent on consumption → MPC = `80 / 100` = 0.8

Investment Multiplier (k):

`1 / (1 - "MPC")` or `"ΔΥ" / "ΔI"` or `1 / "MPS"`

Change in Income (ΔY):

= ΔY = k × ΔI

(b) Change in Consumption (ΔC):

= ΔC = MPC × ΔY 

So, Multiplier (K) = `1 / (1 - 0.8)`

= `1 / 0.2`

= 5

Change in Income (ΔY) = 5 × 1200

= 6000 cr

Change in Consumption (ΔC) = 0.8 × 6000

= 4800 cr