Question

Assuming for a hypothetical economy, government induces an additional investment of ₹ 1,000 crore and 80 percent of additional income is spent on consumption.

Estimate the values of the following :

(i) Investment multiplier (K)

(ii) Change in income (∆Y)

Hint:

Use K = 1/(1 - MPC) with MPC = 0.8 to get 5. Then multiply K by the extra investment of Rs. 1,000 crore.

Answer 1

Step 1: Understand the data:
The government induces extra investment, so change in investment \(\Delta I = Rs. 1,000\) crore.
80 percent of extra income is spent on consumption, so MPC = 0.8.
MPC is the share of extra income that people spend on consumption.

Step 2: Recall the formula for the multiplier:
Investment multiplier \(K = \frac{1}{1 - MPC}\).
It tells us how many times income rises for each rupee of extra investment.
Change in income is \(\Delta Y = K \times \Delta I\).

Step 3: Find the investment multiplier (part i):
\[ K = \frac{1}{1 - 0.8} = \frac{1}{0.2} = 5 \]
So every rupee of new investment raises income by 5 rupees.

Step 4: Find the change in income (part ii):
\[ \Delta Y = K \times \Delta I = 5 \times 1,000 = 5,000 \]
Income rises by Rs. 5,000 crore.

Final Answer:
The investment multiplier is 5 and the change in income is Rs. 5,000 crore. \[ \boxed{K = 5,\ \Delta Y = Rs.\ 5,000\ crore} \]