Multiplier
Introduction
The concept of multiplier was first developed by Richard F. Khan
in 1931. Khan’s multiplier was the Employment multiplier.
Keynes took the idea from Khan and developed the Investment
Multiplier.
In economics or macroeconomics, a multiplier is a factor of
proportionality that measures how much an endogenous
(dependent) variable changes in response to a change in some
exogenous (independent) variable.
Definition of Multiplier
Y= f(x) or Y= f(x, x)
Example
suppose variable x changes by 1 unit, which causes another
variable Y to change by M units. Then the multiplier is M.
Understanding the definition
In economics, the multiplier effect refers to the idea that an initial
spending rise can lead to even greater increase in national income.
In other words, an initial change in aggregate demand can cause a
further change in aggregate output for the economy.
Investment multiplier is simply the multiplier effect of an injection
of investment into an economy.
In general, a multiplier shows how a sum injected into an economy
travels and generates more output.
Multiplier
It must be noted that the extent of the multiplier effect is dependent
upon the marginal propensity to consume. Also that the multiplier
can work in reverse as well, so an initial fall in spending can
trigger further falls in aggregate output.
Preliminary terms
Consumption function: It is a mathematical expression of the
relationship between aggregate consumption expenditure (C) and
aggregate disposable income (Y) expressed as C= f(Y)
Consumption accounts for the largest proportion of the aggregate
demand in an economy and plays a crucial role in the
determination of National Income.
Types of multiplier
1. Investment multiplier
2. Government tax multiplier
3. Government-purchases multiplier
4. Money multiplier
5. Foreign trade multiplier
6. Deposit multiplier
7. Super multiplier
8. Fiscal policy multiplier
9. Employment multiplier
1.Investment multiplier
The ratio of change in income to change in investment is called as
investment multiplier.
M= ∆Y/∆I = 1/ 1-b
2. Government tax multiplier
The ratio of change in income to change in income tax is called the
government tax multiplier.
= ∆Y/∆T = -MPC/ 1-MPC
Example
= ∆Y/∆T = -0.6/ 1-0.6 = -1.5
3. Government-purchases multiplier
The ratio of change in income to change in government purchases
is called as government purchases multiplier.
= ∆Y/∆G = MPC/ 1-MPC
Example
= ∆Y/∆T = 1/ 1-0.6
= 1/0.4 = 2.5
4. Money multiplier
The ratio of change in money supply to change in monetary base is
called as money multiplier.
= ∆MS/∆MB
5. Foreign trade multiplier
Foreign trade also known as the exports multiplier.
The ratio of change in national income to change in exports is
called as foreign trade multiplier.
= ∆Y/∆X
6. Deposit multiplier
The ratio of change in total deposit to change in reserves is called
as deposit multiplier.
= ∆D/∆R or ∆I/∆R
7. Super multiplier
The ratio of change in induced investment to change in income is
called as super multiplier.
= ∆I/∆Y
8. Fiscal policy multiplier
The ratio of change in consumption to the change in government
deficit is called as fiscal policy multiplier.
= MPCd /1-MPCd
9. Employment multiplier
The ratio of change in employment to the change in primary
employment is called as employment multiplier.
= ∆N2/∆N1
Consumption function
C = a + bY
C= Aggregate consumption expenditure; Y= total disposable
Income; a = autonomous consumption. This is the level of
consumption that would take place even if income was zero. If an
individual's income fell to zero some of his existing spending could
be stained by using savings.
b =marginal propensity to consume (mpc). This is the change in
consumption divided by the change in income. Simply, it is the
percentage of each additional rupee earned that will be spent.
Mpc = ∆C/ ∆Y= b
Investment Multiplier
Multiplier (m) = ∆Y/∆I = 1/ 1-b
This relationship can be arrived at by understanding the shift in the
aggregate demand function.
As the demand curve shifts upward due to additional investment
∆I, the real income of the economy also increases by ∆Y
Assumptions of Multiplier
There is a change in investment.
Marginal propensity to consume is constant.
Consumption is a function of current income.
There are no time lags in the multiplier process.
There is net increase in investment.
No government, so Y = Yd
Note that since there is no government, taxes are zero, so Y = Yd,
since:
Yd = Y – T
Yd = Y – 0
Yd = Y
Thus while the consumption function is usually C = a + bYd,
here it will simply be:
C = a + bY
solving the equation
Y=C+I (1)
C = a + bY (2)
Substituting equation (2) into equation (1), i.e., replace C with a +
bY, we get:
Y = a + bY + I (3)
Subtracting bY from both sides:
Y - bY = a + I (4)
solving the equation
Solving for Y
Y - bY = a + I (4)
Factoring out the Y from the left hand side of equation (4)
Y (1 - b) = a + I (5)
Dividing both sides by (1 - b):
Y 1 / 1 b( a I )
The multiplier
Y 1 / 1 b( a I )
where 1/(1-b)—or 1 divided by the MPS—is the multiplier, or the
feedback mechanism that amplifies any initial increase (injection) or
decrease (withdrawal) in aggregate demand. Therefore, Y, the
equilibrium level of output (income) is determined by the multiplier
and total injections. The total injections in this simple model are a + I.
Keynesian model - numerical
example
Given:
Y=C+I
C = a + bY
Y= a+ bY+ I
Where:
a = 100
b = .75
I = 300
Solving for Y
Y = 100 + .75Y + 300
Y - .75Y = 100 + 300
Y (1 - .75) = 100 + 300
Y (.25) = 100 + 300
Y = (1/.25) x 400
Y = 4 x 400
Y = $1600 billion
solving for consumption
and savings
Once we have Y, we can find C and S:
C = a + bY
C = 100 + .75 (1600)
C = 100 + 1200 = 1300
S = -a + (1 - b)Y (saving is the amount of income which is not spent
on Consumption)
S = -100 + (1 - .75) 1600
S = -100 + .25 (1600) = 300
double-checking savings
Also:
Y=C+S
Y–C=S
1600 – 1300 = 300
Also:
S = I (savings = investment at equilibrium)
300 = 300
Acceleration
Introduction
The term acceleration principle was first introduced into economics
by J.M. Clark in 1917. It was further developed by Hicks,
Samuelson, and Harrod in relation to the business cycles.
The principle of acceleration is based on the fact that the demand
for capital goods is derived from the demand for consumer goods
which the former help to produce.
Acceleration Theory
The principle of acceleration states that if demand for consumption
goods rises, there will be an increase in the demand for factor of
production, say machine, which is used to produce the goods. In
other words, the accelerator measures the changes in investment
goods industries as a result of changes in consumption goods
industries.
K.K. Kurihara, “The acceleration co-efficient is the ratio between
induced investment and an initial change in consumption”.
The accelerator theory was introduced by T.N. Carver in 1903 and
J. M. Clark in 1917.
Later on , it was rigorously developed by economists like Harrod,
Solow, Samuelson, Hicks, etc. In trade cycle theory.
The accelerator theory explains the interrelationship between
customer goods industries and capital goods industries in an
economy.
It states that when the demand for consumer goods increases, the
demand for capital goods also increase, i.e., there is positive
association between capital goods and consumer goods industries.
According to Samuelson, accelerator (v) is as defined the ratio of
change in investment to the change in consumption demand, i.e.
V=∆I/∆C
Where,
∆I= Change in investment outlays
∆C = Change in Consumption demand
According to Hicks, accelerator (V) is the ratio of change in
investment to the change in the level of output. i.e., V=∆I/∆Y
Where,
∆I=Change in investment outlays
∆Y = Change in the level of output.
How the Acceleration
Principle Works
If an increase in consumer demand is rapid and sustained, then
more businesses will undertake new capital investment. That is
because investments to boost output often require significant fixed
outlays and take time to build.
Assumptions
Capital output ratio remains constant.
There should be excess capacity in the capital goods industries.
There is permanent change in consumption demand.
The supply of resources should be elastic so that the investment in
capital goods industries can be increased easily.
There should be elastic supply of cheap credit.
Technology remains constant.
There is absence of time lag.
Hence, the acceleration co-efficient is the ratio between induced
investment to a net change in consumption expenditures.
Symbolically, β = ∆I/∆C
Where, β=Acceleration co-efficient
∆I = Net change in investment outlays
∆C = Net change in consumption outlays
Suppose, change in expenditure on Consumption (∆C ) = Rs. 10
Crores.
Change in investment outlays (∆I) = Rs. 20 Crores.
We have, β= ∆I/∆C = 20/10 = 2
It implies, that Rs. 1 increase in demand for consumption goods
leads to Rs. 2 increase in demand for investment outlays.
Thus the principle of acceleration is based on the fact that the
demand for capital goods is derived from the demand for consumer
goods. The acceleration principle explains the process by which a
change in demand for consumption goods leads to a change in
investment on capital goods.
–Thank you
