Marginal propensity to consume (MPC) | Economics Help
Investment Multiplier and Income: Meaning and Relationship with MPC, MPS! (a) Meaning: Investment increases productive capacity which, in turn, raises the. The formula for the simple multiplier is 1/MPS or 1/(1-MPC). MPC + MPS = 1 Click here to visit our frequently asked questions about HTML5 video. Multiplier refer to the increment amount of Income due to increase in the investment in the economy, Multiplier is directly related to the value of MPC in the economy: Below is the State the central problems of an economy.
Marginal propensity to consume (MPC)
And I think you see where this is going. So it's going to be-- I'll write it here-- it's going to be 0. So you're going to have 0. That's going to be 0. And I'll just calculated it.
And it goes on and on and on. So the way to think about that, so the total-- and we could view it either way. Remember, you could view kind of the GDP. You could view that as the aggregate output. You could view that as the aggregate income, aggregate expenditure. These are all views because really the economy is a very circular thing.
One person's expenditure turns into another person's income.
Investment Multiplier and Income: Meaning and Relationship with MPC, MPS
But we could say total output here, measured in our agreed upon currency, which is let's say dollars. So that was 0. And that gave us that 0. And then the last one we did, it would keep going on and on forever, theoretically, is you're going to have plus 0. And this would keep going on and on forever.
We could then would be plus 0. Keep going on and on forever. And one of the fascinating things about mathematics, and maybe the next video, I'll reprove this. I've proven this in multiple playlists, is that you can actually sum up because this value right over here is less than 1, this actually ends up being a finite sum. You can actually take this infinite sum and get a finite number. And we are left with-- well if we factor of 1, there you get 1 plus 0.
And in the next video, maybe I'll prove it, just for fun. But this right over here, it's an infinite sum of a geometric series. And this will actually simplify to-- I'll do it in the same green color-- as 1 over 1 minus 0. So whatever this number is right over here, it'll be 1 minus 1 over that. And so in this case, this would be equal to 1 over 0.
So there's two interesting ideas that are going here. One is, when people get a little bit more income, they're going to spend some of it. And that's where the marginal propensity to consume is.
You essentially have this multiplier effect, that that 1, got spent, some fraction of that gets spent, then some fraction of that gets spent.
So we have this relationship here is that whatever the marginal propensity to consume is, that drives the multiplier. And all the multiplier is saying is if you spend an extra dollar in this economy, given people's marginal propensity to consume, how much will that increase total output? The process of increase in income stops when change in income becomes equal to change in saving.
The process of working of multiplier is further illustrated in the following table. The above table clearly shows that Initial increase in investment of Rs crore has resulted in an increase of additional income of Rs crore, i. Keeping in view the significance of concept of investment multiplier, Keynes suggested that in the situations of unemployment and depression, government should Increase volume of its investment in public utility works to give quick start to economy.
Graphic Presentation of Multiplier: The effect of multiplier can be illustrated with the help of the following graphical Fig. Here OX measures national income and OY saving and investment. At the equilibrium point of E, saving and investment are equal and income is Rs crore. At the new equilibrium point E1, national income is Rs crore. This shows that with investment increase of RS 10 crore, national income has increased by RS 40 crore.
The increase in investment is shown by a small arrow whereas increase in national income is shown by a long arrow. This indicates that national income has increased by four times the increase in investment, i. Thus, K varies directly with value of MPC.
Determination of Income and Employment (Test Questions)
In short, higher the value of MPC, higher will be the value of multiplier. Lower the value of MPC, lower will be the value of multiplier K.
Minimum and Maximum Value of Multiplier: