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

  1. Investment generates income that is a change in investment = change in income in the beginning. ∆ I = ∆ Y
  2. Additional income causes a change in consumption expenditure, that is, a change in income causes a change in consumption expenditure. ∆ Y = c ∆ Y
  3. Additional consumption expenditure means the generation of additional income.
  4. 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∆Yc∆Y∆S
120200.5 X 20 = 1010
2100.5 X 10 = 55
350.5 X 5 = 2.52.5
42.50.5 X 2.5 = 1.251.25
51.250.5 X 1.25 = 0.750.75
..........

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:

Investment Multiplier

Types of Employment Equilibrium

Concept of Short-Term Equilibrium

Aggregate Supply

Aggregate Demand

Introduction To Money

Central bank and its function

Process of credit creation

Precautions while calculating the national income

Real and nominal GDP

National income

National income formula list

Value-added method

Income method

Expenditure method

GDP and welfare

Domestic territory and national residents

Circular flow of income

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