Page 128 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 7: Concept of Multiplier

7.1 Concept of Multipliers Notes

Multiplier coefficient refers to the multiple increases in the equilibrium level of income caused
by a change in the level of aggregate spending. The investment part of the total spending is
determined by the market mechanism ad is relatively more dynamic determinant of output,
employment and income. The value of the multiplier is mainly determined by the value of
marginal propensity to consume.
Spending creates income. It leads to rise in income of those producers on whose goods and
services the spending is made. The spending may be on capital goods (called investment), on
inputs, and on consumption. (It is assumed that there is no government expenditure and there
are no net exports).
If the spending is done out of the increase income without any decrease in the existing income
of the society, it has one impact on income creation. If the spending is done out of the increased
income of one section of the society obtained by reducing the income of other section of the
society, there is another impact.

Example: Suppose government collects income by way of tax and spends on people
there may not be any net increase in income. This is because taxes reduce income of the people
which may lead to reduced spending by the people.

Spending has multiple effects on national income depending upon MPC. If A makes purchase
from B, B’s income rises. Out of this increased income, B makes purchases from C. This raises C’s
income. In this way, there is multiple increase in income in relation to the initial spending. How
many times is the increase depends upon MPC.

Self Assessment

State whether the following statements are true or false.
1. Spending leads to rise in income of those producers on whose goods and services the
spending is made.
2. Spending has multiple effects on national income depending upon MPC.
3. If the spending is done out of the increased income of one section of the society obtained
by reducing the income of other section of the society, there is no impact.
4. Spending can lead to creation of income.

7.2 Types and Limitations of Multipliers

There are several types of multipliers. We will discuss the major ones.

7.2.1 Investment Multiplier

Generally speaking, multiplier is defined as the ratio of change in the equilibrium national
income to change in an autonomous variable. A variable is autonomous when it is assumed not
to be influenced by change in income.
Investment multiplier is the ratio of change in income due to a given change in investment. The
term ‘multiplier’ signifies that change in income is a multiple of change in investment. The
process of income increase is initiated by the change in investment.

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