Question

The simple multiplier for the increase in income ($\Delta Y$) to the increase in investment ($\Delta I$) is equal to :

• A. Marginal propensity to consume (MPC)
• B. Marginal propensity to save (MPS)
• C. Inverse of marginal propensity to consume (1/MPC)
• D. Inverse of marginal propensity to save (1/MPS)

Hint:

The lower the MPS, the less money is saved, meaning more money is spent. This spending acts as income for others, leading to a larger multiplier effect.

Answer 1

The Correct Option is D

Step 1: Understanding the Concept:
The investment multiplier measures the relationship between an initial change in investment spending and the resulting larger change in total national income.
Key Formula or Approach:
The investment multiplier formula is derived from the income identity:
\[ Y = C + I \] Taking changes in variables:
\[ \Delta Y = \Delta C + \Delta I \] Dividing by $\Delta Y$:
\[ 1 = \text{MPC} + \frac{\Delta I}{\Delta Y} \] Since $\text{MPC} + \text{MPS} = 1$:
\[ \text{MPS} = \frac{\Delta I}{\Delta Y} \] Taking the reciprocal, the investment multiplier ($k$) is:
\[ k = \frac{\Delta Y}{\Delta I} = \frac{1}{\text{MPS}} \]

Step 2: Detailed Explanation:
The derived formula shows that the multiplier is represented by $\frac{1}{\text{MPS}}$.
The expression $\frac{1}{\text{MPS}}$ is mathematically the inverse of the Marginal Propensity to Save (MPS).
A lower propensity to save means higher consumption leakage rounds, which results in a larger overall increase in income.

Step 3: Final Answer:
The definition is the "Inverse of marginal propensity to save (1/MPS)", which matches Option (D).