How an intial increase in investment affects the level of final income of the economy? Show its working with a suitable numerical example.?

Question

Answer

Investment increases productive capacity which, in turn, raises the level of output, employment and income.

When investment increases by a certain amount, aggregate income increases by a multiple of that investments

This multiple is called multiplier. Investment multiplier shows a relationship between initial increment in investment and the resulting increment in national income.

It is a measure of change in national income caused by change in investment. Thus, it explains the relationship between increase in investment and the resultant increase in income. For example, if an increase in investment of Rs 50 crore causes an increase in national income of Rs 300 crore, then value of multiplier would be 6 (= 300 ÷ 50).

This equals increase in income divided by increase in investment. The implication of K = 6 is that for any level of change in investment in the economy income will change 6 times of investment amount. Multiplier (K), thus, is the ratio of increase in national income (∆Y) due to an increase in investment (∆I). Put in symbols:

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Answer

Increase in investments impacts the level of total final income in an economy due to the investment multiplier effect in place.

The multiplier concept can be referred to enhance employment, direct as well as indirect and an increase in basic investment.

Example –If Rs 100 crores is an investment in a nation and there is an increase in the total national income by Rs 300 crores then the multiple occurred is 3. If by investing the same income is Rs 400 crore the multiplier is 4.😋

Answer

Introduction:
An initial increase in investment can have a significant impact on the level of final income in an economy. This increase in investment leads to an expansion in economic activities, which in turn generates more income and employment opportunities. In this response, we will provide a numerical example to illustrate the relationship between initial investment and the level of final income in an economy.

Numerical Example:
Let's consider a hypothetical economy that produces only two goods: cars and televisions. Initially, the economy has a total investment of $10 million, which is used to purchase capital goods such as machinery, equipment, and factories. This investment will lead to an increase in the production capacity of both cars and televisions.

Impact on Production and Employment:
As a result of the initial investment, the production of both cars and televisions will increase. Let's assume that the investment leads to a 10% increase in the production of both goods. Before the investment, the economy produced 100,000 cars and 50,000 televisions. After the investment, the production will increase to 110,000 cars and 55,000 televisions.

This increase in production requires additional labor, leading to an increase in employment opportunities. Assuming a constant labor productivity, the economy will require additional workers to produce the increased quantity of cars and televisions.

Impact on Income:
The increase in production and employment opportunities will result in a higher level of income in the economy. The additional workers employed in the production process will earn wages, which will contribute to their disposable income. This increase in disposable income will lead to higher consumption expenditure.

Assuming a marginal propensity to consume of 0.75, which means that individuals spend 75% of their additional income, the initial increase in investment of $10 million will lead to an increase in final income by $7.5 million. This is calculated as follows: $10 million (initial investment) * 0.75 (marginal propensity to consume) = $7.5 million (increase in final income).

Conclusion:
In conclusion, an initial increase in investment has a positive impact on the level of final income in an economy. This increase in investment leads to an expansion in production, employment, and income. The additional income generated from the investment contributes to higher consumption expenditure, further stimulating economic growth. This example illustrates the multiplier effect, where an initial increase in investment leads to a larger increase in the final income of the economy.

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