Keynesian multiplier theory indicates the cumulative
effects of change in investment on income through their
effects on consumption expenditure.
Multiplier is the number which multiplied by the
additional investment (∆ I ) gives the additional increase
in national income. It is defined as " the ratio of the total
change in income to the intial change in investment.
Since, multiplier is related with the effect of changes in
investment on consumption expenditure, multiplier is
related with the marginal propensity to consume (i.e.
mpc = ∆ C / ∆ Y ).
It means multiplier is determined by mpc.
In other words, it is determined as 1/ (1-mpc) or 1/mps
whereas mps implies for marginal propensity to save.
The size of multiplier effect depends upon the size of
mpc. Greater the mpc, bigger will be the value of the
Theoretically, the value of multiplier can range from one to
infinite but in reality it can not be one because
consumption always increases when income increases.
Or, in other words, marginal propensity to consume is
The value of multiplier can not be equal to infinity because
Keynes assumes that mpc is less than unity.
If mpc is zero, the multiplier will be unity because the
induced consumption expenditure is zero.
Multiplier Process: Effect of Investment on National Income (Y = C + I)
Round Spending on Process Resulting change in
aggregate demand and
First Investment 20.0 Direct impact
Second Consumption 20.0 x 0.8 = 16.0 Induced increase in
consumption = 0.8 mpc
Third Consumption 16.0 x 0.8 = 12.8
Fourth Consumption 12.8 x 0.8 = 10.2
Fifth 10.2 x 0.8 = 8.2
Total increase in
100 billion This story goes on and on
till it reaches to 100 billion
[20(1/(1 - 0.8)].
K = 1/(1-MPC) = 1/MPS
C = c + mpc.Y
C = 200 + 0.75Y
MPC+MPS = 1
1. There is no change in the marginal propensity to
consume during the adjustment process which remains
more or less constant.
2. There is no induced investment (i.e. accelerating is not
3. The new higher level of investment is maintained long
enough for the completion of the adjustment process.
4. The output of consumer goods is responsive to
5. There is no time lag between the receipt of income and
The concept of multiplier is an important tool for
analyzing growth, planning and projecting the
investment requirement of an economy given the
Given the mpc, the planners can easily work out the
investment requirement to achieve a targeted
1. Higher mpc implies higher multiplier. It means
that the less developed countries with higher
mpc would grow at a much higher rate than the
developed countries with a lower mpc. But this is
not true. The actual multiplier depends upon a
number of other factors.
2.The working of mpc assumes that those who earn
income as a result of certain autonomous
investment, would continue to spend a certain
percentage of their newly earned income on
consumption. This assumption may not hold true
in reality as people may like to spend part or
whole income on: saving, debt cancellation,
imports, price inflation, hoarding, purchase of
stock and shares from the shareholders,
purchase of second hand car or old house. These
activities do not generate new demand. These
are called as leakages in the consumption flows
which reduce the rate of multiplier.
3.The working of multiplier also assumes that
goods and services are adequately available.
If there is a shortage of goods and services,
the actual consumption expenditure will be
reduced what ever the rate of mpc.
Consequently, multiplier will be reduced. If
expenditure continues to increase in the face
of scarcity, it generates inflation , not the real
4. Under the condition of of the full
employment , the theory of multiplier does
not work because goods and services can
not be produced in excess of their full
John Richard Hicks
(8 April 1904 – 20 May 1989)
Autonomous investment (Ia) : independent of national
Induced (private) investment (Ip): dependent with nation
income or when GNP increase by delta Y, Ip increases
by delta Ip. In other words, induced investment is new
investment stimulated by an increase in aggregate
Marginal Propensity of invest (MPI): the ratio of the two
absolute changes is known as the MPI, which may be
expressed as: MPI = Delta Ip/Delta Y
GNP, National income,
GNP, National income (Y)
What is the importance of induced investment in
the theory of income determination?
The answer has been given by J.R. Hicks in 1951.
He has proved conclusively that the induced
investment makes the value of the Keynesian
multiplier larger and he developed the concept of
supermultiplier, the new concept.
The term supermultiplier was first coined by J.R.
Hicks in his business cycle theory.
The objective was to show the relationship
between change in induced investment and the
corresponding change in income.
To be more specific, it includes the ratio between
the two changes i.e. in investment and in
The concept of supermultiplier is the mathematical
combination of multiplier of Keynes and
accelerator of Aftalian.
Prof. J.R. Hicks has interacted both multiplier and
accelerator with a view to measuring the total
effect of initial investment on income.
The combined effect of the multiplier and the
accelerator is also called the leverage effect.
The supermultiplier is worked out by combining
both induced consumption (MPC) and induced
investment (MPI). Defined as;
◦ K’ = 1 / ( 1- MPC – MPI)
The supermultiplier is thus defined as the ratio of
change in income to a change in autonomous
investment when the induced investment is also
(MPC = 0.50)
(MPI = 0.4)
income (Delta Y
= MPC + MPI)
1st - - - -
2nd 50.00 - - 50.00 50.00
3rd 25.00 20.00 45.00 95.00
4th 22.50 18.00 40.50 135.50
5th 20.25 16.20 36.45 171.95
6th 18.23 14.58 32.81 204.76
7th 16.40 13.12 29.52 234.28
8th 14.76 11.81 26.57 260.85
9th 13.29 10.63 23.91 284.77
10th 11.96 9.57 21.52 306.29
11th 10.76 8.61 19.37 325.66
12th 9.69 7.75 17.43 343.09
13th 8.72 6.97 15.69 358.79
14th 7.85 6.28 14.12 372.91
. . . . .
. . . . .
0 0 0 500.00
K' = 1 / (1-0.5-.4) K' = 10
Note: When K' is 10, the initial investment grow
equivalent to 10 fold in terms of national income
When we introduce the induced investment in
autonomous investment, the total investment will
have two components:
a) autonomous (Ia) and
b) induced (Ip)
The simple multiplier implies that investment is the central
determinant of output.
The super multiplier combines the multiplier with the accelerator
that indicates that investment is not only autonomous, but is part
of derived demand.
Hence, the super multiplier indicates that capacity adjusted
output is determined by autonomous demand.
The GDP measures the market value of all final goods
and services produced within an economy in a given
GDP only measures current production. Transfer
payments and transactions involving goods produced in
other periods are not included in the calculation of GDP.
Transfer payments – are transactions wherein one party is not obliged to
deliver a good or service in return for the payment. Examples: retirement
benefits, unemployment benefits, scholarships, and donations.
The market value of good i (Vi) is equal to Pi⋅Qi
GDP = sum of the market values of all final goods
and services produced within the year.
= = ×∑ ∑
i i i
i 1 i 1
GDP V P Q
1. Expenditure Approach – measures GDP as the sum
of expenditures on final goods and services.
2. Income Approach – measures GDP as the sum of
incomes of factors of production (wages, rent,
interest and profit.
3. Value-added Approach – measures GDP as the sum
of value added at each stage of production (from
initial to final stage)
GNP = GDP + Net Factor Income from the Rest of
the World (NFIRW)
NFIRW - measures the difference between the
earnings of Nepalese residents in other countries
and foreign residents in the Nepal
Gross Domestic Product GDP 4,022,700
Net Factor Income from the
Rest of the World
Gross National Product GNP 4,290,200
Measures how much output or income was produced
or received, on the average, by an individual in an
Useful for comparing the performance of a country
overtime and a country’s performance relative to its
GDP per capita
Personal disposable income represents the
income that households are free to spend or
Ignores income distribution
Ignores environmental degradation
Does not include activities that do not go through
the formal markets sectors
Does not include “illegal” activities like drug
trafficking, prostitution, moonlighting
Country or GDP nominal GDP PPP GDP PPP per capita
Asia 18,515,000 24,077,000
Afghanistan 16,631 29,616 1000 South Asia
Bangladesh 105,402 257,545 1,600 South Asia
Bhutan 1,397 3,785 5,600 South Asia
India 1,537,966 4,060,392 3,339 South Asia
Maldives 1,433 1,755 5,483 South Asia
Nepal 15,108 35,231 1,250 South Asia
Pakistan 164,792 464,711 2,789 South Asia
Sri Lanka 48,241 104,124 5,103 South Asia