Page 130 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 7: Concept of Multiplier

1 Notes
Since Y equals (a+I) times ( ) with ‘a’ held constant, Y will change only with change in Y
1– b
( Y), and it will be equal to:
1
Y = I times
1–b
1
Or Y = I ( )
1–b
Because b = MPC, the expression becomes

1
Y = I
1–MPC
1
= I
MPS

1
Multiplier =
MPS
Working of Multiplier

Example: Suppose I 100 and MPC 0.8. Investment means spending on capital
goods. This raises income of the sellers of capital goods by 100. This is first round increase
in Y.
Since MPC=0.8, 80% of the first round increase in Y is spent on C, i.e. 80. This raises income of
suppliers of consumers goods by 80. This is second round increase in Y. Similarly, the third round
increase in Y is 80% of the second round, i.e. 64. The income goes on increasing round after
round. The sum of all such increases is 500, i.e. 5 times the I .
Note that given MPC = 0.8, MPS = 0.2, with increase in Y, saving (S) also increases by 20%. Saving
means ‘not spending’. When the sum total of increases in S becomes 100, increase in Y stops.

To sum up:
1 1
Y = I.K = I = I (where K = multiplier)
1–MPC MPS
1 1
= 100 = = 500
1– 0.8 0.2
The working is summarized in the Table 7.1.

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