Question

Explain the process of working of Investment Multiplier, for a hypothetical economy with Marginal Propensity to Consume (MPC) as 0.8 and Incremental Investment as ₹ 3,000 crore.

Hint:

Show the rounds: income rises by 3,000, then 2,400, then 1,920 and so on. Multiplier = 1/(1 - 0.8) = 5, so total income rises by Rs. 15,000 crore.

Answer 1

Step 1: Understand the multiplier:
The investment multiplier shows how much national income rises when investment rises by one rupee. It works because one person spending becomes another person income.
The given values are: MPC = 0.8 and increase in investment = Rs. 3,000 crore.

Step 2: Round 1:
Firms spend Rs. 3,000 crore on investment goods. This becomes income of the people who supply them, so income rises by Rs. 3,000 crore.
These people spend 0.8 of it on consumption: 0.8 x 3,000 = Rs. 2,400 crore. They save the rest: Rs. 600 crore.

Step 3: Round 2 and later rounds:
The Rs. 2,400 crore spent becomes income of other people. They spend 0.8 x 2,400 = Rs. 1,920 crore and save Rs. 480 crore.
This chain goes on in round after round. Each round is 0.8 times the one before, so the amounts get smaller and smaller.

Step 4: Show the rounds in a table:

Round	Increase in investment (change in I) Rs. crore	Increase in income (change in Y) Rs. crore	Increase in consumption (change in C) Rs. crore	Increase in savings (change in S) Rs. crore
1	3,000	3,000	2,400	600
2	-	2,400	1,920	480
3	-	1,920	1,536	384
...	...	...	...	...
Total	3,000	15,000	12,000	3,000

Step 5: Add up the rounds:
Total rise in income = 3,000 + 2,400 + 1,920 + ... = Rs. 15,000 crore. Total rise in consumption = Rs. 12,000 crore. Total rise in saving = Rs. 3,000 crore.
Saving rises by exactly the amount of the first investment, and this is when the process stops.

Step 6: Find the multiplier:
\[ K = \frac{1}{1 - MPC} = \frac{1}{1 - 0.8} = \frac{1}{0.2} = 5 \]
\[ \Delta Y = K \times \Delta I = 5 \times 3000 = 15000 \]

Final Answer:
An increase in investment of Rs. 3,000 crore raises national income by Rs. 15,000 crore. This is 5 times the increase in investment. \[ \boxed{K = 5, \ \Delta Y = \text{Rs. } 15{,}000 \text{ crore}} \]