Using a hypothetical example, elaborate the working of investment multiplier in an economy.

Question

Accepted Answer

The investment multiplier demonstrates how an initial change in investment leads to a magnified change in national income. Consider an example where autonomous investment increases by ₹100 crores and MPC = 0.5.

Multiplier (k) = 1/(1-MPC) = 1/(1-0.5) = 1/0.5 = 2

Working:
- Round 1: Initial investment of ₹100 crores generates ₹100 crores income for workers and suppliers.
- Round 2: Recipients spend 50% (MPC = 0.5), i.e., ₹50 crores on consumption, generating ₹50 crores income for others.
- Round 3: Next recipients spend ₹25 crores (50% of ₹50 crores).
- This process continues with each round generating half the income of the previous round.

Total increase in income = k × ΔI = 2 × ₹100 = ₹200 crores.
Thus, an initial investment of ₹100 crores generated ₹200 crores of total income, demonstrating the multiplier effect.