Understanding the Multiplier Effect
When investment increases by 100 crores, it triggers a chain reaction in the economy, leading to a larger increase in overall income. This phenomenon is known as the multiplier effect.
Investment Increase
- An initial increase in investment (I) of 100 crores is expected to influence the total income (Y) through increased spending.
Consumption Function
- The consumption function is given as C = 10 + 0.6Y.
- This indicates that consumption (C) increases with income (Y), where 10 is the autonomous consumption and 0.6 is the marginal propensity to consume (MPC).
Calculating the Multiplier
- The formula for the multiplier (k) is: k = 1 / (1 - MPC).
- Substituting the given MPC of 0.6, we find:
- k = 1 / (1 - 0.6) = 1 / 0.4 = 2.5.
Total Income Increase
- The increase in income (ΔY) can be calculated by multiplying the initial investment increase by the multiplier.
- Thus, ΔY = k * ΔI = 2.5 * 100 crores = 250 crores.
Conclusion
- The initial 100 crores investment leads to an overall income increase of 250 crores due to the multiplier effect.
- This demonstrates the significance of investment in stimulating economic growth and enhancing national income.
This analysis underscores the importance of understanding how changes in investment can reverberate through the economy, impacting consumption and overall income levels.