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concept-of-multiplier-

Keynesian s multiplier effect states relationship between income and investment under certain conditions

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concept-of-multiplier-

  1. 1. Concept of Multiplier - Economics
  2. 2. John Maynard Keynes, 1919 and 1945
  3. 3. CONCEPT OF MULTIPLIER THE AGGREGATE DEMAND IS COMPOSED OF : 1. CONSUMPTION DEMAND 2. INVESTMENT DEMAND FROM THE CONCEPT OF MULTIPLIER IT IS KNOWN HOW MUCH OR HOW MANY TIMES INCOME INCREASES AS INVESTMENT IS DONE.
  4. 4.  AS INVESTMENT INCREASES NATIONAL INCOME INCREASES PROPORTIONATELY MUCH MORE.  HOW MANY TIMES IT INCREASES DEPENDS ON MPC.  HIGHER THE MPC THE NATIONAL INCOME WILL BE GREATER DUE TO INVESTMENT.
  5. 5. MARGINAL PROPENSITY TO CONSUME  RATIO OF CHANGE IN CONSUMPTION TO CHANGE IN INCOME INDICATE THAT PART OF ADDITIONAL INCOME WHICH IS NOT SPENT ON CONSUMPTION.  EG. NATIONAL INCOME = 1200CR FROM 1000CR  CONSUMPTION EXPENDITURE = 900CR FROM 800CR  MPC = 100/200 =.5
  6. 6. INVESTMENT THAT PART OF INCOME WHICH IS USED FOR FURTHER PRODUCTION EXPENDITURE MADE FOR THE CREATION OF NEW CAPITAL ASSETS LIKE MACHINE, TOOLS, BUILDING ETC. TYPES OF INVESTMENT – AUTONOMOUS INVESTMENT  PRIVATE OR PUBLIC INVESTMENT  INDUCED INVESTMENT
  7. 7. The Keynesian system: Planned and actual investment Investment has three components: • Plant and equipment -- drill presses, factory buildings, etc. • Residential investment -- new housing construction • Inventory investment -- Change in Business Inventories .
  8. 8. The Consumption Function: the key to Keynes Consumption depends on the level of DISPOSABLE INCOME (disposable personal income = income - taxes = Y - T) Some consumption is autonomous (= “independent” of DPI): it may depend on other factors such as wealth or stock values. (even at zero income, Bill Gates would consume something) The consumption function proposed by Keynes is: C = C 0 + C y ( Y - T) C 0 = Autonomous consumption C y = Marginal propensity to consume The marginal propensity to consume plays a central role in the Keynesian system. Keep your eye on the MPC in the following slides.
  9. 9. MULTIPLIER • CHANGE IN INVESTMENT LEADS TO CHANGE IN NATIONAL INCOME  CHANGE IN NATIONAL INCOME IS A MULTIPLE OF CHANGE IN INVESTMENT  THIS MULTIPLE IS TERMED AS MULTIPLIER OR INVESTMENT MULTIPLIER  INVESTMENT MULTIPLIER IS A MEASURE OF CHANGE IN NATIONAL INCOME AS A RESULT OF CHANGE IN INVESTMENT.  EG. NATIONAL INCOME INCREASES BY 300CR AS A RESULT OF INCREASE IN INVESTMENT OF 100CR  K=3(300/100)
  10. 10. ASSUMPTIONS OF MULTIPLIER  THERE IS AUTONOMOUS INVESTMENT IN ECONOMY  MARGINAL PROPENSITY TO CONSUME REMAINS CONSTANT  CONSUMPTION IS THE FUNCTION OF CURRENT INCOME  NO TIME LAG BETWEEN RECIEPT OF INCOME AND ITS DISPOSAL IN FORM OF CONSUMPTION  NET INCREASE IN INVESTMENT  SUPPLY OF CONSUMER GOODS IS ALWAYS IN ECONOMY
  11. 11. FEATURES OF MULTIPLIER  IT IS ASSOCIATED WITH CHANGE IN INVESTMENT  SIZE OF MULTIPLIER DEPENDS UPON SIZE OF MPC  MULTIPLIER WORKS IN BOTH FORWARD AND BACKWARD DIRECTION  VALUE OF MULTIPLIER VARIES FROM UNITY TO INFINITY
  12. 12. SIZE OF MULTIPLIER  HIGHER THE MPC –LARGER THE MULTIPLIER SIZE  LARGEST POSSIBLE MPC IS UNITY  IF MPC IS ZERO MULTIPLIER IS UNITY K=1/1-MPC THAT IS RECIPROCAL OF MARGINAL PROPENSITY TO SAVE
  13. 13. USES OF MULTIPLIER  TOOL OF ANALYSYING GROWTH, PLANNING, PROJECTING, INVESTMENT REQUIREMENT  TOOL FOR ACHIEVING TARGETED GROWTH RATE, IF MPC IS GIVEN  TOOL FOR ANALYSING THE FLUCTUATIONS IN THE ECONOMY  IMPORTANT TOOL FOR ANALYSING IMPACT OF TAXATION, FOREIGN TRADE ON THE ECONOMY
  14. 14. LIMITATIONS OF A MULTIPLIER  MULTIPLIER DEPENDS ON A LARGE NUMBER OF FACTORS ALONG WITH MPC  EFFICIENCY OF PRODUCTION  REGULAR INVESTMENT  MULTIPLIER PERIOD  FULL EMPLOYMENT CEILING  ASSUMPTION THAT GOODS AND SERVICES ARE AVAILABLE IN ADEQUATE SUPPLY  GOODS AND SERVICES CANNOT BE PRODUCED IN EXCESS OF THEIR FULL EMPLOYMENT LEVEL
  15. 15. IMPORTANCE OF MULTIPLIER  USEFUL TO ANALYZE PUBLIC INVESTMENT  REMOVES DEPRESSION THROUGH GOVERNMENT INVESTMENT  ACHIEVING FULL EMPLOYMENT  MARGINAL EFFICIENCY OF CAPITAL EMPLOYMENT RISES  PRIVATE INVESTMENT ENCOURAGED
  16. 16. 3 CONCEPTS OF MULTIPLIER  STATIC MULTIPLIER  COMPARATIVE STATIC MULTIPLIER  DYNAMIC MULTIPLIER
  17. 17. EMPLOYMENT MULTIPLIER  PROPOUNDED BY KAHN  GOVERNMENT UNDERTAKES PUBLIC WORKS,THIS LEADS TO INITIAL AND PRIMARY EMPLOYMENT.  THIS RESULTS IN INCREASE IN DEMAND FOR CONSUMPTION GOODS WHICH IN TURN PROVIDES MORE EMPLOYMENT.
  18. 18. MULTIPLIER AND UNDERDEVELOPED COUNTRIES Does not applies to underdeveloped countries like India. REASONS: 1.DEMANDS CAN BE MET EASILY IN DEVELOPED COUNTRIES. 2.SUPPLY OF RAW MATERIALS IS ELASTIC IN DEVELOPED COUNTRIES. 3.THERE IS NO INVOLUNTARY EMPLOYMENT.
  19. 19. LEAKAGES IN INCOME STREAM AND THEIR EFFECT ON MULTIPLIER  PAYING OF DEBTS  IDLE CASH BALANCES.  IMPORTS.  PURCHASE OF EXISTING SECURITIES.  PRICE INFLATION
  20. 20. Keynesian equilbrium: Solution procedure Start with the equation in general form: Y = C0 + Cy ( Y - T) + Ip + G + NX Substitute in the given numbers: Y = 300 + 0.8 ( Y - 1000) + 1500 + 1200 + 500 Collect all the constant terms: Y = 3500 + 0.8Y - 800 Y = 2700 + 0.8Y Subtract 0.8 Y from both sides of the equation: 0.2 Y = 2700 Finally, multiply both sides by 1 / 0.2 = 5 Y = 5 (2700) = 13, 500
  21. 21. The Multiplier Rerun the previous exercise, raising planned investment by 500. Y = 300 + 0.8 ( Y - 1000) + 2000 + 1200 + 500 Collect all the constant terms: Y = 4000 + 0.8Y - 800 Y = 3200 + 0.8Y Subtract 0.8 Y from both sides of the equation: 0.2 Y = 3200 Finally, multiply both sides by 1 / 0.2 = 5 Y = 5 (3200) = 16, 000 GDP is UP BY 2,500, NOT up by only 500. Investment spending has a MULTIPLIER EFFECT of 5

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