Question

Describe working of dynamic multiplier in case the investment increases once for all and investment increases repeatedly.

Answer 1

The working of the dynamic multiplier involves a chain reaction where an initial investment generates income, which then leads to further consumption, creating new income in successive rounds, with each round being smaller due to savings. If investment increases once for all, the total income increases by a multiple of the initial investment, with the process eventually ending as consumption declines to zero. If investment increases repeatedly, the income increase in each period is compounded by the new investment, leading to a larger overall income change that grows over time rather than stabilizing at a new equilibrium.

Investment increases once and for all:

1. Initial investment: An increase in investment (e.g., from a government project) directly raises the income of those who supply the labour and materials for that investment.
2. First round income: This initial investment leads to a first-round increase in income equal to the amount of the investment.
3. Subsequent rounds:
   • The recipients of this initial income will spend a portion of it on consumption, determined by the Marginal Propensity to consume (MPC).
   • This consumption spending becomes new income for others (e.g., sellers of consumer goods).
   • These new income recipients, in turn, spend a part of their income, creating more income for yet another group.
4. Multiplier process: This cycle of spending and re-spending continues, with each round of income and consumption being smaller than the last.
5. Total income: The cumulative effect of all these rounds of spending results in a total increase in national income that is a multiple of the initial investment, calculated by the formula ΔY = `ΔI × (1 / (1 - MPC))`.

Investment increases repeatedly:

1. Intermittent investment: In this scenario, investment doesn't just increase once but is added to the economy in consecutive periods or rounds.
2. Cumulative effect: The impact of the multiplier is compounded. In each period, the initial investment for that period raises income.
3. Growing income: This increase in income is then subject to the multiplier effect, and the new income generated by that multiplier is then affected by the next round of additional investment.
4. No stabilization: Unlike the “once for all” scenario where the income effect eventually settles, repeated investment keeps increasing aggregate demand, leading to a continuous and larger expansion of income. The total increase in income grows over time as each period’s initial investment and induced consumption create a progressively larger income base.