SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &

ACCELERATOR

www.practicemock.com 1 [email protected] 011-49032737

 SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &
Table of Content
ACCELERATOR

Table of Content ........................................................................................................... 2

Multiplier ..................................................................................................................... 3
Key Determinants of the Value of the Multiplier ............................................................................................... 3
Size of the Savings Ratio ................................................................................................................................ 3
Amount Spent on Imports ............................................................................................................................... 3
Level of Taxation ............................................................................................................................................ 3
Marginal Propensity to Consume (MPC) ........................................................................................................... 3
The Multiplier Effect and the Effectiveness of Fiscal Policy ............................................................................. 4
Impact of the Multiplier on Aggregate Demand ............................................................................................. 4
Reverse Multiplier .............................................................................................................................................. 4
Accelerator .................................................................................................................. 5
Conditions to Operate for an Accelerator Model ................................................................................................ 5
Illustration ....................................................................................................................................................... 5
Importance and Limitations of Multiplier and Accelerator ................................................................................ 6
Difference between Multiplier and Accelerator ................................................................................................. 6

www.practicemock.com 2 [email protected] 011-49032737

 SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &
Multiplier
ACCELERATOR
A multiplier broadly refers to an economic factor that, when increased or changed,
causes increases or changes in many other related economic variables. For
example, change in any of the components of government expenditure may have more
effect on the GDP than just the value of the change is known as the multiplier effect. Say,
government has increased its expenditure on healthcare. This increased expenditure will
be spent on a number of factors viz. salary increase of doctors & nurses, new equipment
and building etc. Buying new equipment will definitely increase business of those who are
producing it & those who are selling it. This 'first round effect' is the big boost to spending
within the economy.

Now, the doctors with their increased salary will spend some part of it. The
producer/provider of these goods & services will get extra business and they will also think
of increasing their labour, equipment’s etc. and so it goes on. Please note that the
amount passed on each time diminishes in each successive round of spending
but the overall injection into the economy is greater than the first sum that was
put into it. Multiplier can be ascertained by dividing the increase in national income that
eventually occurs by the increase in injections that caused it.

Multiplier = (Change in GDP)/(Change in Injections)

Key Determinants of the Value of the Multiplier

Size of the Savings Ratio
More people save the increase in income, less is the increase in spending at each stage of
the process.
Amount Spent on Imports
If a major chunk of this extra spending goes on to buy imported goods/ services, the
money will go overseas and no major effect of it will be felt in the economy.
Level of Taxation
Increase in government spending will definitely increase income and will consequently
generate a higher tax revenue. If this extra revenue is spent on public sector investment
and employment, it will serve the process of multiplier better.

Marginal Propensity to Consume (MPC)

Overall, the value of the multiplier therefore depends on the amount of any increase in
income that is spent by the people receiving it. This is known as the marginal propensity
to consume (MPC). The higher the MPC, the higher the value of the multiplier will be. So,

The marginal propensity to consume is the proportion of each extra pound of

income spent by households.
Multiplier = 1/(1-MPC) = 1/(MPS)

www.practicemock.com 3 [email protected] 011-49032737

 SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &
The Multiplier Effect and the Effectiveness of Fiscal Policy
ACCELERATOR
The multiplier concept may be used to show how the use of fiscal policy to combat
unemployment can be very effective. Expansionary fiscal policy may involve an increase
in government expenditure. That will have the effect of shifting the AD curve to the right.
Part of the Keynesian argument concerning the effectiveness of such a policy relates to
the multiplier effect.

Government’s own expenditure provides only the first round of the increased expenditure.
The recipients of increased government contracts or government salaries increase their
consumption demand, and the recipients of this increased purchasing power are in turn
able to increase their demand for goods and services and so on.

The result is that the final increase in AD will therefore be larger than the initial increase
in government expenditure that caused it.

Impact of the Multiplier on Aggregate Demand

In the figure above, an increase in government expenditure shifts the AD (aggregate
demand) curve to the right to ADg. The level of income therefore rises to Yg. In time, the
first round of effects of the increase in government expenditure give rise to the second
and third round effects and so on, such that the final level of aggregate demand is at AD2
and the level of income is at OY2. The initial change in AD is the distance Y1Yg. The final
change in income is Y1Y2 and so the multiplier will be the final change divided by the
initial change that caused it.

Reverse Multiplier
A withdrawal of income from the circular flow will lead to a downward multiplier
effect. Therefore, whenever there is an increased withdrawal, such as a rise in savings,
import spending or taxation, there is a potential downward multiplier effect on the rest of
the economy.

www.practicemock.com 4 [email protected] 011-49032737

 SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &
Accelerator
ACCELERATOR
If the demand for consumption goods rises, there will be an increase in the demand of the
machines which produce these goods. After all, these machines will be aiding to
manufacture the demanded goods. But these machines’ demand will increase at a
faster rate than the increase in demand of the original goods. An accelerator makes
the level of investment a function of the rate of change in consumption and not of the
level of consumption. So, an accelerator measures the changes in investment goods
industries as a result of long-term changes in demand of consumption goods
industries.

The acceleration coefficient is the ratio between induced investments to a given net change
in consumption expenditures.

v = ΔI/ΔC
v => acceleration coefficient
ΔI => net changes in investment outlays
ΔC => net changes in consumption outlays

For example, say there is an increase in the demand of salt and manufacturers have added
equipment of Rs 20 crores to increase the production of salt worth Rs 10 crores. Here the
accelerator is 2.
When the production of increased consumer goods doesn't lead to an increase in the
demand for capital equipment producing them, the accelerator is zero.
The concept of accelerator depends upon the below 2 factors:
● Capital-output ratio
● Durability of the capital equipment

Please note that if the percentage change in consumption is constant, the percentage
change in induced investment will depend directly on the durability of the machine. Higher
the durability of machine is, greater will be the value of accelerator. Also note
that, if there is a decline in the demand of consumption goods, the decline in investment
can’t exceed the rate of depreciation.

Conditions to Operate for an Accelerator Model

The below 3 conditions must be met for the functioning of the accelerator model.
● Existing capacity is fully utilised.
● Finances are adequate to permit satisfaction of accelerator-generated demand.
● Change in output is thought to be non-temporary.

Illustration
Let’s have a look at a coffee shop which has 2 coffee machines producing 100 cups of
coffee each in a day. The exact demand of coffee in that street is 200 cups which is served
by this specific coffee shop. Say, a new office opens up in the street and the demand for
coffee goes up to 250 cups of coffee per day. If the coffee shop owner assumes that the
demand will remain constant, and will continue growing in the future, he can buy a new
coffee machine. This new demand will be met and there will be an extra capacity of 50
cups of coffee.

www.practicemock.com 5 [email protected] 011-49032737

 SEBI GRADE A 2020: ECONOMICS- MULTIPLIER &
Hence, following the increase in demand of 25%, capital stock increases by 50%, and the
ACCELERATOR
‘accelerator effect’ from this decision is ‘2’.

Importance and Limitations of Multiplier and Accelerator

The multiplier-accelerator interaction shows that the investment goods industries fluctuate
more violently than the consumption goods industries. It has helped us to show that small
demand changes in consumption goods industries lead to considerably enlarged changes
in investment goods industries. That said, there are certain presumptions in the theory of
multiplier and accelerator such as a fixed ratio of consumer to capital goods, constant
replacement demand, no excess capacity, permanent demand etc. which really are very
difficult to follow in the real life and this is a limitation of the concept of accelerator.

Difference between Multiplier and Accelerator

● Multiplier shows the effect of a change in investment on income and employment
whereas accelerator shows the effects of a change in consumption on investment.
In other words, in the case of multiplier, consumption is dependent upon investment,
whereas in the case of accelerator investment is dependent upon consumption.
● Multiplier depends upon the propensity to consume and accelerator depends upon
durability of the machines. In other words, the former is dependent upon
psychological factors, while the latter is dependent upon technological factors.
● Multiplier works as rigorously in the reduction of income as it does in its
increase. But the working of the accelerator is restricted in the downward
direction to the rate of replacement of capital because businessmen can at the most
disinvest to the extent of not replacing the wearing-out capital.

www.practicemock.com 6 [email protected] 011-49032737