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THEORY OF MULTIPLIER
Principles of Macroeconomics
Theory of Multiplier
Dr. Rajneesh Mishra
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Multiplier theory
• Is there any relationship between change in aggregate • R.F. KAHN
demand and change in National Income? • Investment Multiplier
• Govt. Exp. Multiplier
• If Yes, what determine the relationship? • Tax Multiplier
• Balanced Budget Multiplier
• What would be the magnitude of change? • Export / Import Multiplier
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Shift in Aggregate Demand AS
C+I+ I
• Change in aggregate demand can be caused due to two reasons:- E2
C+I
C
1. Change in Consumption E1
Expenditure
2. Change in Investment
S
I+ I
O Y1 Y2
-S Income
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Simple model of Multiplier
• Increase in autonomous investment cause an upward shift in aggregate
demand curve • Y= C+ I
• Y=b Y+ I
• Increase in national income implies that point E1 represented a less than
full employment situation • Y (1-b) = I
• Y= 1/ 1-b * I
• Y/ I = 1/1-b = k
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How Multiplier process works Numerical
Suppose mpc= 0.8
Autonomous investment= Rs. 1000 crore
• Suppose C= 100+ 0.75Y
Rounds of Income generation Consumer Spending Income generation • I= 200
• I= 100
First round 1000 • Find Y, Y and k (Multiplier)
Second round 800 800
Third round 640 640
Fourth round 512 512
Fifth round 409.6 409.6
………….. …………. ………..
Total 5000
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MPC M= 1/1-mpc
Uses of Multiplier
0.00 1.00
0.10 1.11 • Importance in Planning and Projections
0.20 1.25 • Importance in fiscal Policy formulation
0.30 1.43 Suppose current NY= $16000 billion
0.40 1.66 Planned growth = 10%
0.50 2.00 MPC= 0.6
0.60 2.50 Calculate Investment requirement?
0.70 3.33
0.80 5.00
0.90 10.0
1.00 Infinity
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Limitations of Multiplier Paradox of saving and multiplier
MPC is known • Is saving a “Virtue”
Leakages from Income stream • The penny saved is penny earned.
Import of goods and services
Purchase of existing wealth
S1
Full employment situation
Saving, Investment
S0
Applicability of Multiplier theory to LDC’s
C E1 E0 I
O Y1 Y0
Income
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Numericals for practice
1. If mpc is 0.75, calculate the value of mps and investment multiplier.
2. In an economy, mpc = 0.75. In this economy what will be the effect on total income if investment increases by Rs
300.
3. Suppose the level of autonomous investment in an economy is Rs. 200 crores and consumption function of the
economy is C = 80 + 0.75Y
(a) What will be the equilibrium level of income?
(b) What will be the increase in national income if investment increases by Rs. 25 crores.
4. In an economy, investment increases from Rs 300 crores to 500 crores As a result of it, total income increases from
Thank you
Rs. 1000 to Rs. 2000 crores. Calculate value of investment multiplier and mps.
5. Suppose you have the following information about a closed economy: C = 50 + 0.80 Y
I =200
Where C is consumption, I is investment and Y is income.
a) Find out the equilibrium level of income.
b) Suppose Investment increases to 275 what is the new equilibrium level of income?
c) What level of I is needed to achieve a target income of 2000?
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