Question

If the value of the Marginal Propensity to Save (MPS) in an economy is exactly \( 0.2 \), what is the magnitude of the investment multiplier (\( K \))?

• A. \( 5 \)
• B. \( 2 \)
• C. \( 4 \)
• D. \( 0.8 \)

Hint:

The multiplier value has a direct relationship with the Marginal Propensity to Consume (MPC) and an inverse relationship with the Marginal Propensity to Save (MPS). A lower savings rate leaves more income circulating as consumer demand, generating a larger multiplier effect.

Answer 1

The Correct Option is A

Concept: The investment multiplier (\( K \)) measures the total change in aggregate income that results from an initial injection of autonomous investment. It shares an inverse mathematical relationship with the leakage rate of savings inside the circular flow model: \[ K = \frac{1}{\text{MPS}} = \frac{1}{1 - \text{MPC}} \]

Step 1: Identify the given saving propensity parameter. The problem provides our core leakage variable: \[ \text{MPS} = 0.2 \]

Step 2: Calculate the multiplier using the direct reciprocal relationship. Substitute the value of MPS into our multiplier equation: \[ K = \frac{1}{\text{MPS}} = \frac{1}{0.2} \] Multiply both the numerator and the denominator by 10 to clear the decimal fraction: \[ K = \frac{10}{2} = 5 \] This indicates that an initial investment injection of \$100 crore will expand total national output and income by \$500 crore.