Question

Illustrate the working of Multiplier.

Answer 1

Working of Multiplier:

1. Suppose the Government undertakes investment expenditure equal to ₹ 100 crores on some public works, by way of wages, price of materials, etc.
2. Thus income of labourers and suppliers of materials increases by ₹ 100 crores. Suppose the MPC is 0.8 that is 80 %.
3. A sum of ₹ 80 crores is spent on consumption (A sum of ₹ 20 Crores is saved).
4. As a result, suppliers of goods get an income of ₹ 80 crores.
5. They in tum spend ₹ 64 crores (80% of ₹ 80 cr).
6. In this manner consumption expenditure and increase in income act in a chain-like maimer.

The final result is ∆Y = 100 + 100 × 4/5 + 100 × [4/5]² + 100 × [4/5]³ or,
∆Y = 100 + 100 × 0.8 + 100 × (0.8)² + 100 × (0.8)³
= 100 + 80 + 64 + 51.2… = 500 .
that is 100 × 1/1 – 4/5
100 × 1/1/5
100 × 5 = ₹ 500 crores
For instance if C = 100 + 0.8Y, I = 100,
Then Y = 100 + 0.8Y + 100
0.2Y = 200
Y = 200/0.2 = 1000 → Point B
If I is increased to 110, then
0.2Y = 210
Y = 210/0.2 = 1050 → Point D
For ₹ 10 increase in I, Y has increased by ₹ 50.
This is due to the multiplier effect.
At point A, Y = C = 500
C = 100 + 0.8 (500) = 500; S = 0
At point B, Y = 1000
C = 100 + 0.8 (1000) = 900; S = 100 = I At point D, Y = 1050
C = 100 + 0.8 (1050) = 940; S = 110 = I
When I is increased by 10, Y increases by 50.
This is multiplier effect (K = 5)
K = `1/0.2` = 5