Question

Elaborate using a hypothetical numerical example, how a given initial increase in investment affects the level of final income of the economy.

Hint:

The multiplier effect demonstrates that an initial increase in investment can have a larger impact on the economy. The greater the MPC, the larger the multiplier and, consequently, the greater the final increase in income.

Answer 1

Let’s assume the Marginal Propensity to Consume (MPC) is 0.75, and the initial increase in investment is ₹ 200 crore. The formula for the multiplier effect is: \[ \text{Multiplier} = \frac{1}{1 - MPC} \] Substituting the given MPC value: \[ \text{Multiplier} = \frac{1}{1 - 0.75} = 4 \] Now, we calculate the final income increase (ΔY) as follows: \[ \Delta Y = \text{Multiplier} \times \text{Initial Investment} = 4 \times 200 = ₹ 800 \text{ crore} \] Thus, the final increase in income in the economy is ₹ 800 crore. This shows how an initial investment of ₹ 200 crore can lead to a larger increase in the overall income of the economy due to the multiplier effect.