The document discusses the multiplier effect in economics. It defines the multiplier effect as how an initial injection of spending, such as increased government spending, creates a ripple effect that increases overall output and employment. It works through consumers receiving more income and spending more, which further increases income and demand. The multiplier is the ratio of the total change in income to the initial change in spending. The document also outlines the assumptions and limitations of the multiplier model, and describes how the multiplier effect can occur through both static and dynamic processes.

1. Multiplier Effect
PRESENTED BY:
PRINSON RODRIGUES

2. What is
Multiplier Effect?
The multiplier effect is a
concept in economics that
describes how an injection
into an economy, such as
an increase in government
spending, creates a ripple
effect which increases
employment and the
output of goods and
services in the economy.

3. The Multiplier
Effect/Multiplier
Process
• A change in one of the components
of aggregate demand can lead to a
multiplied final change in the level
of GDP.
• The multiplier effect comes about
because injections of new demand
for goods and services into the
circular flow of income stimulate
further rounds of spending – in
other words “one person’s
spending is another’s income.”
• This can lead to a bigger eventual
effect on output and employment.

4. How does it work?
An injection occurs in the economy, such as an increase in government
spending.
The injection increases the aggregate demand in the economy for goods and
services.
The increase in demand for goods and services causes firms to employ more
workers and expand output.
As firms are employing more workers, more people have disposable incomes
and subsequently the aggregate demand increases in the economy.
The increases in aggregate demand causes firms to employ more workers
and the effect continues as before.

5. Assumptions of Multiplier Effect
Keynes’s theory of the multiplier works under certain assumptions which
limit the operation of the multiplier. They are as follows:
• There is change in autonomous investment and that induced investment is
absent.
• The marginal propensity to consume is constant.
• Consumption is a function of current income.
• There are no time lags in the multiplier process. An increase (decrease) in
investment instantaneously leads to a multiple increase (decrease) in income.
• The new level of investment is maintained steadily for the completion of the
multiplier process.
• There is net increase in investment.

6. • Consumer goods are available in response to effective demand for them.
• There is surplus capacity in consumer goods industries to meet the
increased demand for consumer goods in response to a rise in income
following increased investment.
• Other resources of production are also easily available within the economy.
• There is an industrialised economy in which the multiplier process
operates.
• There is a closed economy unaffected by foreign influences.
• There are no changes in prices.
• The accelerator effect of consumption on investment is ignored.
• There is less than full employment level in the economy.

7. Types of Multiplier Effects
Every time there is an injection of new demand into the circular
flow there is likely to be a multiplier effect. This is because an
injection of extra income leads to more spending, which creates
more income, and so on. The multiplier effect refers to the
increase in final income arising from any new injection of
spending. Depending on the purpose of analysis sometimes a
distinction is made between the static multiplier and the
dynamic multiplier.

8. Static Multiplier
The concept of static multiplier implies that changes in
investment causes change in income instantaneously. It means
that there is no time lag between the change in investment and
the change in income. It implies that the moment a rupee is
spent on investment project, society’s income increases by a
multiple. Let us explain the concept of the dynamic multiplier
also known as period and sequence multiplier

9. Dynamic Multiplier
The concept of dynamic multiplier recognizes the fact that the
overall change in income as a result of the change in investment
is not instantaneous. There is a gradual process by which
income change as a result of change in investment or other
determinants of income. The process of change in income
involves a time lag. The multiplier process works through the
process of income generation and consumption expenditure.

10. Derivation of Multiplier Effect
The essence of multiplier is that total increase in income, output or
employment will multiply the original increase in investment. For
example, if investment equal to ₹ 100 crores is made, then the income
will not rise by ₹100 crores only but a multiple of it.
The multiplier is the ratio of increment in income to the increment in
investment.
If ΔI stands for increment in investment and ∆Y stands for the
increase in income, then multiplier is equal to the ratio of ΔY to ΔI.
Therefore k =
Δ𝑌
Δ𝐼
.

11. If ΔY stands for increase in income, ΔI stands for increase in investment
and MPC for marginal propensity to consume, we can write the equation
ΔY = ΔI 1/1-MPC
ΔY/ΔI = 1/1-MPC
ΔY/ΔI measures the size of the multiplier. Therefore,
Size of multiplier or k =
1
1−𝑀𝑃𝐶
.
1 – MPC = MPS
Multiplier =
1
1−𝑀𝑃𝐶
=
1
𝑀𝑃𝑆
.

12. Y = C + I
ΔY = ΔC + ΔI
C = a + bY
ΔC = bΔY
Therefore, after this;
ΔY = bΔY + ΔI
ΔY – bΔY = ΔI
ΔY (1 – b) = ΔI OR
ΔY =
1
1 −𝑏 𝑜𝑟 1 −𝑀𝑃𝐶
∆𝑌
∆𝐼
= 1
1 −𝑏
=
1
𝑀𝑃𝑆

13. Limitations of Multiplier Effects
Consumption is strictly a function of income and the MPC of the
society remains unchanged.
The value of the multiplier is limited by the availability of
consumption goods.
It is necessary that the increments in investment are repeated in
regular time intervals.
Multiplier includes any type of investment (public or private) but it
specially applies to loan financed public investment.
We must be sure that any act of investment in one sector of the
economy is not offset by a decline in investment in some other
sector of the economy.

14. The value of the multiplier is further restricted by the
limitation provided by the full employment ceiling.
Working or value of multiplier depends upon the fact whether
economy is closed or open.
Smooth and better working of multiplier also depends upon
the availability of other factors and resources of production.
It assumes that there is no change in prices of commodities
and raw materials, etc.
There is no time lag between income and consumption.

15. Thank You…