Multiplier

R.F.Kahn 1931 (Employment

multiplier)
Keynes
The General Theory of Employment,
Interest and Money (1936)
Investment Multiplier

Meaning
Increase in level of equilibrium
income for a unit increase in
autonomous spending.
Ratio of change in income due to
change in investment.

Dig.

Change
in
Investme
nt

Change
in
income

Change in
Consumpti
on

Change
in
income

Formula
Multiplier = Change in
income/change in Investment
K = Y/ I
Illustration: If investment increases
by Rs. 15 cr. and as a consequence
income increases by rs. 60 cr., then
multiplier is
4

Size of multiplier
Depends on MPC
Larger the MPC , Larger is the
multiplier
Larger the MPS, Smaller is the
multiplier

Relation between Multiplier and MPC

Direct relationship
Relation between Multiplier and MPS
Reciprocal

Infinity Multiplier

Unity Multiplier

Multiplier = 2

C
Consumption

C
Consumption

Consumption
O

AS

Income

Incom
e

MPC = 1

MPC = Zero

Income

MPC = 0.5

K = Y/ I (i)
Y=C+I
Y = C + I or
I = Y - C
Putting the value of I in eq (i)
K = Y/ Y C
Dividing by Y
K = Y/ Y
Y C/ Y
Or K = 1 / 1 MPC
K = 1/ MPS

Multiplier mechanism explained

assuming MPC = 0.5
Roun
d

Increase in
investment
expenditure

Change in
income

Induced
change in
consumpti
on

Leakages
or Saving

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

100
----------

100
50
25
12.50
6.25
3.12
1.56
0.78
0.39
0.20

50
25
12.50
6.25
3.12
1.56
0.78
0.39
0.20
0.10

50
25
12.50
6.25
3.12
1.56
0.78
0.39
0.20
0.10

Total

100

200

100

100

Here I = 100, and Y = 200, so K = 2

Withdrawal (leakages) of multiplier

Idle saving
Purchase of shares and govt. securities
Paying of old debts
Import
Excess stock of consumption goods
High liquidity preference
Price inflation
Taxation system
Undistributed profits of companies

Illustration
1. MPC = 0.5, calculate K.
2. MPS = 0.2. calculate K.
3. MPC = 0.5, Y = Rs. 1000,
Calculate I.
Rs.500
4. If MPC = 0.75, how much
additional investment is required to
increase income by Rs. 600? Also
find the value of multiplier.
Rs. 150, 4

 5. Find MPC when investment

multiplier = 1.
Ans. Zero
6. Find the value of multiplier when
MPC = MPS.
Ans. 2
7. In an economy investment
expenditure increased by Rs. 400 cr.
And MPC = 0.8. calculate increase in
income and increase in saving.
Ans. Rs. 2000 cr. And Rs. 400 cr.

Forward action and backward action

of multiplier
With increase in investment,
multiplier increases income many
times more.
With decrease in investment,
multiplier decreases income many
times more.

Expenditure

Influence of forward action of the

multiplier is more in those countries
where MPS is small, while MPC is large.

AS
E1
E

Y
Y1
Income

AD1 (C+I+I)
AD (C+I)

Important Note
Equilibrium level of output/income
does not necessarily correspond to
AS
nt
Full Employment Yin the economy.
e
m
ploy
Expenditure

l em
l
u
f
AD2
Over
ent
m
y
o
l
p
AD1
Full em

ent
m
y
o
l
r emp
e
d
n
U

AD

X
Employment

Deflationary gap

Underemployment equilibrium
Deficient demand (AD<AS)
Resources are not fully utilized
Excess capacity
Deflationary gap is the shortfall in AD
from the level required to maintain
full employment equilibrium in the
economy.

Aggregate Demand

ent
Defici

Income/Output

ADf
nd
Dema
ADu

Causes
Reduction in private consumption
expenditure
Reduction in investment expenditure
Reduction in government
expenditure
Decline in exports
Rise in imports
Increase in tax rates

Inflationary Gap
Excess demand

Causes
Increase in private consumption
expenditure
Increase in investment expenditure
Increase in government expenditure
Increase in exports
Decrase in imports
Cut in tax rates

Measures to correct deficient and

excess demand
Government expenditure
Fiscal and monetary measures

Reverse Action of multiplier

Assumptions of multiplier
MPC remains constant
Induced consumption is not due to
induced investment
Closed economy
Less than full employment level
Continuous investment
No government interference
Surplus capacity
Prices are stable

Dynamic concept of
multiplier
The consumption of the current
period depends on the income of the
previous period.
There is a time lag between
investment and income

Dynamic multiplier and change in

investment
Single injection of investment:
It will result into change in income
only once, thereafter income will
revert back to its old level.
Continuous injection of investment
Effect of multiplier will be permanent.