Question

What are the important limitations of size and working of the investment multiplier?

Answer 1

1. Assumes constant MPC: In reality, MPC may change at different income levels, affecting multiplier accuracy.
2. Neglects foreign trade: The basic multiplier assumes a closed economy, but in an open economy, imports act as leakages.
3. Ignores supply constraints: The theory assumes output will always increase with demand. But in many cases, supply shortages or lack of infrastructure may prevent this.
4. Time lags and delays: The multiplier assumes an instant response, but in practice, the effects take time to appear.
5. Valid only under unemployment: The multiplier works best when there is unemployment and underused resources. If the economy is at full employment, it may cause inflation instead of growth.