Posted by
Anjali Kaur
on
Oct 19, 2020
Working of Investment Multiplier
The multiplier is represented by K. The investment multiplier works on a simple theory that the number of times by which the increase in income exceeds the increase in investment. It is measured as the ratio between the change in income and change in investment. Let’s understand the working of Investment Multiplier in detail.
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Assumptions about the investment multiplier
- Investment generates income that is a change in investment = change in income in the beginning. ∆ I = ∆ Y
- Additional income causes a change in consumption expenditure, that is, a change in income causes a change in consumption expenditure. ∆ Y = c ∆ Y
- Additional consumption expenditure means the generation of additional income.
- The process of investment multiplier keeps on repeating itself until the time total increase in income becomes equal to the product of multiplier (K) and change in investment. ∆ Y = K X ∆ I
I know it is confusing. Let’s try with numerical example.
Numerical on the Working of Multiplier
Remember 1 thing, multiplier or investment multiplier means the same.
Now, assume:
∆ I = 20, MPC = 0.5. Find ∆ Y.
We know that,
So,
k = 2
∆ Y = K x ∆ I
∆ Y = 2 X 20 = 40
The multiplier process keeps repeating till the time additional income generated becomes 40.
| Time | ∆I | ∆Y | c∆Y | ∆S |
|---|---|---|---|---|
| 1 | 20 | 20 | 0.5 X 20 = 10 | 10 |
| 2 | 10 | 0.5 X 10 = 5 | 5 | |
| 3 | 5 | 0.5 X 5 = 2.5 | 2.5 | |
| 4 | 2.5 | 0.5 X 2.5 = 1.25 | 1.25 | |
| 5 | 1.25 | 0.5 X 1.25 = 0.75 | 0.75 | |
| .. | .. | .. | .. | .. |
This cycle will keep repeating till ∆ Y sum becomes 40.
In the next post, I will explain some numericals on this topic.
Thank You for reading.
You can read the related post on macroeconomics:
Types of Employment Equilibrium
Concept of Short-Term Equilibrium
Precautions while calculating the national income
Domestic territory and national residents
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