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Question
Assuming that increase in investment is Rs1000 crore and marginal propensity to consume is 0.9, explain the working of the multiplier.
Solution
Given that
Value of MPC = 0.9
An initial increase in investment = Rs 1000 crore
So, every increase of Re 1 in the income, 0.9 part of the increased income will be consumed
by people.
Consumption= Rs 0.90
Saving= Rs 0.10
| Round | Increase in investment ΔI |
Change in income ΔY |
Induced change |
Savings ΔS |
| 1 | 1000 | 1000 | 900 | 100 |
| 2 | - | 900 | 810 | 90 |
| 3 | - | 810 | 729 | 81 |
| 4 | - | 729 | 656.1 | 72.9 |
| 5 | - | 656.1 | 590.49 | 63.54 |
| 6 | - | 590.49 | 531.44 | 54.44 |
| 7 | - | 531.44 | 478.29 | 53.15 |
| 8 | - | 478.29 | 430.46 | 47.83 |
| 9 | - | 430.46 | 387.42 | 43.04 |
| 10 | - | 387.42 | 348.67 | 38.75 |
| 11 | - | 348.67 | 313.81 | 34.86 |
| 12 | - | 313.81 | 282.42 | 31.39 |
| 13 | - | 282.42 | 254.18 | 29.24 |
| 14 | - | 254.18 | 228.76 | 25.42 |
| 15 | - | 228.76 | 205.89 | 22.87 |
| 16 | - | 205.89 | 185.30 | 20.59 |
| 17 | - | 185.30 | 166.77 | 18.53 |
| 18 | - | 166.77 | 150.09 | 16.68 |
| 19 | - | 150.09 | 135.08 | 15.01 |
| 20 | - | - | - | - |
| 21 | - | - | - | - |
| 22 | - | - | - | - |
| 23 | - | - | - | - |
| 24 | - | - | - | - |
| 25 | - | - | - | - |
| 26 | - | - | - | - |
| 27 | - | - | - | - |
| 28 | - | - | - | - |
| 29 | - | 1.31 | 1.17 | 0.14 |
| 30 | - | 1.17 | 1.06 | 0.11 |
| Total | 10000 | 9000 | 1000 |
The above shows the process multiplier which continues and the income will increase due to increase in consumption
Changes in the income (AY)=Rs 10,000
Change in the investment (Al)= Rs 1,000
As we know that
`k = 1/(1-MPC) = (ΔY)/(ΔI)`
`k = 1/(1- 0.9) = (ΔY)/1000`
`1/0.1 = (ΔY)/1000`
ΔY = 10000
Hence, an initial increase in the investment by 1,000 crore lead to an increase in income and output by its 10,000 crore.
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