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Question
Assuming that increase in investment is Rs. 800 crore and marginal propensity to consume is 0.8, explain the working of multiplier
Solution
Given that the value of MPC = 0.8 and the initial increase in investment is Rs 800 crore. For every increase of Re 1 in the income, people consume 0.8 part of the increased income. So, people consume Rs 0.80 and save Rs 0.20.
Process of multiplier
| Round | Increase in Investment ΔI |
Change in income ΔY |
Induced Change in Consumption ΔC |
Savings ΔS |
| 1 | 800 | 800 | 640 | 160 |
| 2 | - | 640 | 512 | 128 |
| 3 | - | 512 | 409.6 | 102.4 |
| 4 | - | 409.6 | 327.68 | 81.92 |
| 5 | - | 327.98 | 264.14 | 63.54 |
| 6 | - | 264.14 | 209.7 | 54.44 |
| 7 | - | 209.7 | 167.7 | 42 |
| 8 | - | 167.7 | 134.2 | 33.5 |
| 9 | - | 134.2 | 107.4 | 26.8 |
| 10 | 107.4 | 85.8 | 21.6 | |
| 11 | 85.8 | 68.64 | 17.16 | |
| 12 | 68.64 | 54.9 | 13.7 | |
| 13 | 54.9 | 43.9 | 11 | |
| 14 | 43.9 | 35.1 | 8.8 | |
| 15 | 35.1 | 28.1 | 7 | |
| 16 | 28.1 | 22.4 | 5.7 | |
| 17 | 22.4 | 17.9 | 4.5 | |
| 18 | 17.9 | 14.3 | 3.6 | |
| 19 | 14.3 | 11.5 | 2.8 |
This process indicates that the income will keep increasing because of increase in consumption.
Change in the income (ΔY) = Rs 4000
Change in the investment (ΔI) =Rs 800
`k = 1/(1 - MPC) = (ΔY)/(ΔI)`
`K = 1/(1- 0.8) = (ΔY)/800`
or `1/0.2 = (ΔY)/800`
Hence ΔY = 4000
Thus, an initial increase in the investment by Rs 8OO crore will lead to an increase of income and output by Rs 4000 crore.
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