Question

Briefly explain the mechanism of the investment multiplier with the help of a schedule. Take initial increase in autonomous investment as ₹ 1000 crores and MPC as 0.8.

Answer 1

The investment multiplier works on the principle that one person’s expenditure is another person’s income. It can be explained with the help of the following schedule:

Initial increase in autonomous investment is ₹ 1,000 crores, and MPC is 0.8 (given).

ΔI = 1000 crores

MPC = 0.8

K = `1/(1 - "MPC")`

K = `1/(1 - 0.8)`

K = 5

K = `"ΔY"/"ΔI"`

5 = `"ΔY"/(1,000)`

ΔY = 5,000 crores

Increase in income = ₹ 5,000 crores.

In this case, national income will continue to rise round after round, but the growth in real terms will decrease with each subsequent round. This increase in income will end when the initial increase in investment equals the gain in savings.

Round	Increase in Income (ΔY)	Increase in consumption expenditure (ΔC = ΔY × MPC)	Increase in savings (ΔS = ΔY − ΔC)
1	1,000	800	200
2	800	640	160
3	640	512	128
4	512	409.6	102.4
-	-	-	-
-	-	-	-
-	-	-	-
All others	2,048	1638.4	409.6
All rounds	5,000	4,000 = (5,000 × 0.8)	1,000 = (5,000 × 0.2)