Question

Explain the working of investment multiplier with the help of a numerical example.

Answer 1

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment. For example investment is increased by 1,000 crore rupees, now

Particulars	Increase in Income (Rs. Crores)	Change in Consumption (Rs. Crores)	Change in Saving (Rs. Crores)
Fist Round	1000	800	200
Second Round	800	640	160
Third Round	640	512	128
All other Rounds	2,560	2,048	512
Total	5,000	4,000	1,000

(a) In the multiplier process, increase in income in the first round is always equal to additional investment. So, Increase in income in the first round =Rs.1,000=Rs.1,000 crores.
(b) The saving off Rs. 200 crores indicates that increase in consumption will be Rs. 800 crores in the first round.
- additonal consumption of Rs. 800 crores out of an additional income of Rs. 1,000 indicates that 80% of income is spent, Le. MPC = 0.8. The values of second and third round are calculated on the basis of this data.
(c) Total Increase in Income = Additional Investment x kxk. In the given case:
Multiplier (k)=11−MPC=11−0.8=5(k)=11−MPC=11−0.8=5
So, Total Increase in Income =1,000×5=Rs.5,000 crores=1,000×5=Rs.5,000crores
(d) Total Increase in Consumption == Total increase in Income ×× MPC =5,000 x 0.8=Rs.4,000 crores=5,000x0.8=Rs.4,000crores.
(e) Total Increase in Saving == Total Increase in Income −− Total Increase in Consumption =5,000−4,000=1,000 crores=5,000−4,000=1,000crores.
(f) Values of All other Rounds' is calculated after subtracting the values of first, second and third round from the total increase in income, consumption and saving respectively.