Chapter 7-11 : Investment Multiplier - Chapter Notes - Commerce PDF Download

INVESTMENT MULTIPLIER

(Q) What is Investment Multiplier and How is measured ?
Ans. When an investment is done in an economy ,income increases more than investment.This multiplied effect is called multiplier.
Thus it refers to ratio of change in income due to change in investment.It is denoted by alphabet “K” where

ΔY = additional income generated

ΔI = additional investment

Suppose govt. invested Rs.50 cr in road project to generate employment and income in the economy and as a result income increases by Rs.200 cr ,we have multiplier K = 200 / 50 = 4 which means every Rs.1 invested in a economy will generate income of Rs.4
Multiplier also have a positive relation with Marginal Propensity to Consume which means higher the propensity to consume - higher will be the value of multiplier .Hence Multiplier can be measured as 

Thus given MPC = .5 (that people consume half of their increased income) value of multiplier would be

MULTIPLIER WORKING or PROCESS or MECHANISM

The operation of multiplier can be understood with following example.Suppose there is increase in investment of Rs.100 cr which results in construction of new buildings.This will increase the income of builder,architect,labour by Rs.100cr.
Now with given MPC = .5 i.e half ,they will together consume or spend Rs. 100 * 1/2 = Rs.50 cr on consumption goods.
The producers of these consumers goods will thus have an increase of Rs. 50 cr and they will further spend half of their increased income on some other goods.
This process will go on with each round of consumption on goods decreasing, as half of increased income will be spend and process will come to end when additional consumption will falls to zero.

Thus total increase in income is 200 cr due to increase in investment of 100 cr

MULTIPLIER ACTION

Multiplier is ratio of change in income due to change in investment and this change in investment causes more than change in income that is by an multiplied amount. This tendency or process works in both ways

RELATIONSHIP BETWEEN MULTIPLIER AND MPC

In the process of Multiplier, consumption of one person is income of another person.With higher marginal propensity to consume people will spent larger portion of increased income on consumption and this will further increase income with more amount and thus higher value of multiplier.
Thus both are positively related that is higher the propensity to consume ,higher is the value of multiplier and vice-versa. This can be understood with the given table

FEATURES OF MULTIPLIER

(1) It works both ways i.e is forward as well as backward
(2) Its value ranges from one to infinity
(3) It has a positive relationship with MPC
(4) It has a negative relationship with MPS
(5) Multiplier is generally taken as increase in income due to increase in investment ,but other component of AD like Consumption , Govt. exp , Increase in export has same effect.
(6) Multiplier DOESN’T WORK IN DEVELOPING or underdeveloped country like India inspite of high consumption level as it is based on assumption that

EXCESS CAPACITY and
INVOLUNTARY UNEMPLOYMENT exist in the country.

In other words Multiplier to work in response to high consumption level there should be corresponding increase in production by utilising excess capacity.
But in poor country there is lack of production capacity and hence production cannot be increased in response to increase in consumpion(demand) and ultimately price rises.This work against the working of multiplier

NUMERCIAL ’ S

TYPE 1

(Q1) Find K if with change in income is 300 cr due to change in investment of 50 cr
(Q2) In an economy investment exp. increases by 10 cr and as a result income increases by 50
cr. Find K

TYPE 2
(Q3)

Find K if (i) MPC = 0 (ii) MPC = .3
(iii) MPC = .9 (iv) MPS = .3
(v) MPS = .4 (vi) MPS = .8

(Q4) Income Consumption Calculate MPS and Multiplier ?
          100      80
          200     160
          300      250

TPYE 3 (USE BOTH FORMULA)

(Q5) MPC = .75 ,if investment expenditure increases by 500cr. Calculate increase in income and consumption ?
(Q6) MPC = .8 ,if expenditure increases by 1000cr.Calculate increase in income and saving ?

(Q7)In an economy the actual level of income is 500 cr whereas the full employment level of income is 800 cr.The MPC = .75. Calculate the increase in investment to achieve full employment level

(Q8) In an economy the level of income is 2000 cr and MPC = .75 . Calculate the total increase in income if investment increases by 200 cr ?

(Q9) What will be the effect on income of an economy if there is a decrease in investment by 50 cr provided the value of multiplier is 5

(Q10) A 200 cr in investment leads to rise in national income by 1000 cr . Find MPC

(Q11) Estimate Value of K when initial investment is 1000 cr and ΔC = 750 cr ?

(Ans K = 4)

(Q12) In an economy 20 % increase in investment results in 100 % increase in income .
Calculate MPC

(Ans K = 0.8)

(Q13) In an economy, the equilibrium level of income falls short by Rs. 500 crores. Calculate the
additional investment needed to achieve the equilibrium level of income, if 80% of increased
income is spent on consumption.

(Ans. Additional Investment required = Rs. 100 crores)

(Q14) The following table illustrates the multiplier process after making an additional
investment of Rs. 1,000 crores. Calculate the missing values.
Increase in Income Change in Consumption Change in Saving
(Rs. in crores) (Rs. in crores) (Rs. in crores)

DRILL YOURSELF

(Q1) In an economy the level of income is 3000 cr and MPC = .75 . Calculate the total increase
in income if investment increases by 400 cr ? Also find new level of income

(Q2) MPC = .8 ,if expenditure increases by 400cr.Calculate increase in income and saving ?

(Q3)MPC = .9 ,if investment exp. increases by 700cr.Calculate increase in income and consumption

(Q4)MPC = .6 ,if investment exp. increases by 600cr.Calculate increase in income and consumption

(Q5)In an economy MPC = .75 and investment is increased by 200 cr.Calculate increase in income and consumption ?

(Q6)In an economy MPC = .95 and investment is increased by 100 cr.Calculate increase in income and consumption ?

(Q7)In an economy investment exp. increases by 10000 cr and as a result income increases by 40000 cr .Find MPS and MPC ?

(Q8) A 125 cr in investment leads to rise in national income by 750 cr . Find MPC

(Q9) How much additional income will be generated in an economy with additional investment of Rs 100 crore and MPC = 1 / 2

(Q10 ) Marginal propensity to consume is zero. Calculate the change in income if investment falls by Rs. 1,000 crores.

(Q11) In an economy, income increase from Rs. 5,000 crore to Rs. 6,000 crore as a result of 20
percent increase in investment. Calculate the value of investment multiplier.

(Ans. 1)

(Q12) If an additional investment of Rs. 500 crores increase the income by Rs. 500 crores in the
first round of the multiplier process, by Rs. 450 crores in the second round, by Rs. 405 crores in
the third round and so on. Determine the total increase in income.

(Ans. Total increase in income = Rs. 5,000 crores)

(Q13) What will be value of multiplier if

(a) MPC = MPS

(b) entire additional income is
converted into additional consumption ?

ANSWERS :: (1)1600 cr (2) 2000 ,400 cr (3)7000 ,6300 cr (4)1500 ,900 cr
(5)800 ,600 cr (6) 2000 ,1900 cr (7) .25 (8) .84
(9) 200 cr (10) 1000 cr (11) 1 (12) 5000 cr
(13) 2 , infinite