Question

Explain the dynamic multiplier by giving suitable examples.

Answer 1

The dynamic multiplier shows how the multiplier effect unfolds over time, not instantly. Unlike the simple multiplier, which assumes immediate change in income, the dynamic multiplier explains how income increases step-by-step over several time periods after an increase in investment.

When investment rises, people who receive the income do not spend all of it at once. Instead, they spend it gradually, and that spending becomes income for others in the following time periods. This creates a chain of spending and income generation over time, leading to the full multiplier effect.

Example: One-time increase in investment:

Suppose the government invests ₹ 100 crores in year 1 and MPC = 0.5. The multiplier is:

K = `1/(1-0.5)`

= `1/0.5`

= 2

The total increase in income will eventually be ₹ 200 crores, but not all at once.

Year 1: ₹ 100 crores (initial investment)

Year 2: ₹ 50 crores (0.5 × ₹ 100 crores)

Year 3: ₹ 25 crores (0.5 × ₹ 50 crores)

Year 4: ₹ 12.5 crores

This continues until the total adds up to ₹ 200 crores.

Example: Repeated increase in investment

Now suppose the government invests ₹ 100 crores every year, and again MPC = 0.5.

Year 1: ₹ 100 crores (first investment)

Year 2: ₹ 100 crores (new) + ₹ 50 crores (from previous year)

Year 3: ₹ 100 crores (new) + ₹ 50 crores (2nd year) + ₹ 25 crores (1st year)

The income keeps rising and overlapping each year.