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How an initial increase in investment affects the level of final income of the economy? Show its working with a suitable numerical example. |
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Answer» Solution :Initial increase in investmentincrease in investmentthe finalincomeof theeconomy. Investmentmultiplierexplainsthis effect, MONEY Multiplier(k) is the ratio of the increasein National Income `(DeltaY)`due ofa givenincreasein investments `(DelatI)` . `K = {DeltaY//DeltaI}` For eg. If an additional investment of 1,000 croresis madeby governmentfor a bullet train project ina country , thisextra investmentwill generate an extraincome of 1,000 crores ,as expenditure of one is incomefor another. ALSO, it is assumed that Marginal Propensityto CONSUME of the countryis 0.8 .Anadditionalinvestmentof 1000 crores `(DeltaI)`madeby governmentwill generate extraincomeof 1000 crores in first round. If MPCof thiscountry is 0.8, the nationalswhoarenationals who are receivingthisadditionalincome willspends 80% portion of thisadditionalincomei.e.,800 crores , whichin return, becomes additionalincome during thirdround . Similarin thirdround, 640 crores of income is generated . Consumptionexpenditure in everyround willbe 0.8 times of additionalincome receivedincome reviewedfromprevious round.  Thus, an initial investment of Rs. 1000 crores leads to a TOTAL increase of Rs. 5000 crores in the income. As a result, Multiple (K) `=(DeltaY)/(DeltaI)=(5000)/(1000)=5` |
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