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How doesan initialincreasein investment affect the level income of the economy? Show its working with a suitable numerical example. |
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Answer» Solution : Initialincrease in investmentleads to multiple times increasein income of the economy. Investment multiplierexplains this Multiplier(k) is the ratio of the INCREASE in National income `(Delta Y)` due to a given increase in investment `(Delta I)`. `k = ((Delta Y)/(Delta I))` Suppose, there is an additional investment of Rs. 1,000 crores is made by governmentfor a bullet train project in a country. Also, it is assumed that Marginal Propensityto Consumeof hte countryis 0.8 . This additional investment of Rs. 1,000 crores `(Delta I)` made by government will generatean extra income of Rs. 1,000 crores in first round. It is because expenditure of one isincome of another. If MPC of this country is 0.8, those who are receivingthis additionalincome will SPEND 80% of this i.e. Rs. 800 crores which in return becomes additionalincome during the second round. Similarly, inthird round Rs. 640 crores of income is generated . In this way income generation goes on increasinground by round and in EVERY round will be 0.8 times of additional incomegenerated in the previous round.  `Delta Y = Delta I XX (1)/(1-MPC) ("where"(1)/(1-MPC) " is multiplier") ` `=1,000xx(1)/(1-0.8)` = Rs. 5,000 crore |
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