Investment Multiplier and its Relation to Marginal Propensity to Consume
Investment Multiplier:
Investment multiplier is a concept in economics that illustrates the relationship between initial spending (investment) and the total increase in national income that results from this initial injection of spending into the economy. It shows how changes in investment can lead to a multiplied effect on the overall income and output of the economy.
- The formula for calculating the investment multiplier is: Investment Multiplier = 1 / (1 - Marginal Propensity to Consume)
Relation to Marginal Propensity to Consume:
Marginal Propensity to Consume (MPC) is the proportion of an increase in income that is spent on consumption rather than saved. The investment multiplier is inversely related to the MPC. This means that as the MPC increases, the investment multiplier decreases, and vice versa.
- Higher MPC: A higher MPC indicates that more of the additional income generated by an initial increase in investment will be spent on consumption, leading to a smaller multiplier effect on national income.
- Lower MPC: Conversely, a lower MPC means that a larger proportion of the additional income will be saved rather than spent on consumption, resulting in a larger multiplier effect on national income.
Overall, the investment multiplier and the marginal propensity to consume are closely related concepts that help to explain how changes in investment and consumption behavior can impact the overall economic activity and income levels in an economy.