Question

Discuss various leakages of the multiplier along with the working of multiplier.

Answer 1

1. Idle savings: When income is saved rather than spent on consumption, the multiplier effect reduces. Even though some of these savings may be invested, the marginal propensity to save (MPS) decreases the multiplier’s size because not all saved income returns immediately as consumption.
2. Imports: Expenditure on imported goods means money leaves the domestic economy, weakening the multiplier effect. If imports exceed exports continuously, the multiplier is adversely affected.
3. Price inflation: Rising prices consume more income but do not increase consumption, reducing the real impact of the multiplier. Inflation raises costs and can limit investment and consumption growth.
4. Debt cancellation: Income used to repay old debts does not increase consumption, thus reducing multiplier effectiveness.
5. Purchases of old stocks and securities: Spending on financial assets rather than consumption goods doesn’t create new production or income, acting as a leakage. 
6. Hoarding: Holding idle cash reduces money circulation, leading to lower consumption and a weaker multiplier effect.
7. Taxes and corporate savings: Taxes reduce disposable income available for consumption, and undistributed corporate profits mean money doesn’t re-enter the spending cycle, both limiting the multiplier effect.
8. High liquidity preference: If individuals prefer holding cash for transactions or safety, consumption decreases, restricting multiplier growth.