Question

If MPC > MPS, what is true about the investment multiplier (K)?

• A. K > 2
• B. K < 2
• C. K = 1
• D. K = ∞

Answer 1

The Correct Option is A

To determine the relationship between the Marginal Propensity to Consume (MPC), the Marginal Propensity to Save (MPS), and the investment multiplier (K), we need to understand the concept of the multiplier in economics. The multiplier (K) is calculated using the formula:

\[ K = \frac{1}{1 - MPC} \]

Where:

• MPC: Marginal Propensity to Consume
• MPS: Marginal Propensity to Save, and MPS = 1 - MPC

Given that MPC > MPS, it implies:

• MPC > (1 - MPC)

Therefore, if MPC > 0.5, then:

• \( K = \frac{1}{1 - MPC} \)

Substituting any value more than 0.5 for MPC (e.g., 0.6):

• \( K = \frac{1}{1 - 0.6} \)
• \( K = \frac{1}{0.4} = 2.5 \)

Hence, when MPC > MPS, the value of K is greater than 2.

Therefore, the correct answer is: K > 2

Answer 2

The investment multiplier (K) is defined as:
K = \( \frac{1} {1−MPC} \), where MPC is the marginal propensity to consume, and MPS is the marginal propensity to save.

Since the MPC and MPS sum to 1, any increase in one leads to a corresponding decrease in the other. A higher MPC indicates that consumers are more likely to spend additional income, which leads to a higher multiplier effect. In contrast, a higher MPS suggests that consumers are more likely to save, reducing the multiplier effect.

When the MPC is greater than the MPS, the multiplier effect increases. This means that any increase in investment will have a greater impact on national income, as more of the additional income is spent, further stimulating demand and economic activity. For instance, if MPC > MPS, the multiplier will be greater than 2, indicating that the effect of the initial investment on national income will be amplified, leading to a more significant overall increase in economic output.