Question

Assuming that increase in investment is Rs. 800 crore and marginal propensity to consume is 0.8, explain the working of multiplier

Answer 1

Given that the value of MPC = 0.8 and the initial increase in investment is Rs 800 crore. For every increase of Re 1 in the income, people consume 0.8 part of the increased income. So, people consume Rs 0.80 and save Rs 0.20.

Process of multiplier

Round	Increase in Investment ΔI	Change in income ΔY	Induced Change in Consumption ΔC	Savings ΔS
1	800	800	640	160
2	-	640	512	128
3	-	512	409.6	102.4
4	-	409.6	327.68	81.92
5	-	327.98	264.14	63.54
6	-	264.14	209.7	54.44
7	-	209.7	167.7	42
8	-	167.7	134.2	33.5
9	-	134.2	107.4	26.8
10		107.4	85.8	21.6
11		85.8	68.64	17.16
12		68.64	54.9	13.7
13		54.9	43.9	11
14		43.9	35.1	8.8
15		35.1	28.1	7
16		28.1	22.4	5.7
17		22.4	17.9	4.5
18		17.9	14.3	3.6
19		14.3	11.5	2.8

This process indicates that the income will keep increasing because of increase in consumption.

Change in the income (ΔY) = Rs 4000

Change in the investment (ΔI) =Rs 800

`k = 1/(1 - MPC) = (ΔY)/(ΔI)`

`K = 1/(1- 0.8) = (ΔY)/800`

or `1/0.2  = (ΔY)/800`

Hence ΔY = 4000

Thus, an initial increase in the investment by Rs 8OO crore will lead to an increase of income and output by Rs 4000 crore.