Understanding the Multiplier Effect
The relationship between investment and national income can be analyzed using the concept of the multiplier effect. When an increase in investment leads to a rise in national income, it highlights the impact of spending in the economy.
Investment and National Income Increase
- An investment of 600 crore leads to an increase in national income by 1800 crore.
- This indicates a multiplier effect, where initial investments create a ripple effect in the economy.
Calculating the Multiplier
- The multiplier (k) can be calculated using the formula:
k = Change in National Income / Change in Investment
- Substituting the values:
k = 1800 crore / 600 crore = 3
Marginal Propensity to Consume (MPC)
- The MPC is defined as the proportion of additional income that consumers will spend on consumption.
- The relationship between the multiplier and MPC can be expressed as:
k = 1 / (1 - MPC)
- Rearranging this formula to find MPC:
MPC = 1 - (1 / k)
- Substituting the value of k:
MPC = 1 - (1 / 3) = 2/3
Conclusion
- The Marginal Propensity to Consume (MPC) is calculated to be 2/3 or approximately 0.67.
- This indicates that for every additional rupee earned, consumers will spend approximately 67 paise, reflecting their spending behavior in response to changes in income.
Understanding these concepts is crucial for analyzing economic policies and their implications on national income and consumption patterns.