Question

In Rs. 80,000 Cr. economy Rs. 7000 Crore are invested. If Marginal Propensity to Consume (MPC) in the economy is 0.50 then, (i) How much income will increase and (ii) what will be the total income of the economy ?

Hint:

If the question gives Marginal Propensity to Save (MPS) instead of MPC, use \(k = \frac{1}{MPS}\).
Remember that \(MPC + MPS = 1\), so if \(MPC = 0.5\), then \(MPS = 0.5\) as well.

Answer 1

Step 1: Understanding the Concept:
The concept of the Investment Multiplier (\(k\)) describes how an initial change in investment (\(\Delta I\)) leads to a final change in national income (\(\Delta Y\)).
The magnitude of this multiplier is determined by the Marginal Propensity to Consume (MPC).
A higher MPC indicates that people spend more of their additional income, leading to a larger circular flow and a higher multiplier effect.
Step 2: Key Formula or Approach:
1. Investment Multiplier (\(k\)) = \(\frac{1}{1 - MPC}\)
2. Change in Income (\(\Delta Y\)) = \(k \times \Delta I\)
3. Total Income (\(Y_{total}\)) = Initial Income (\(Y\)) + Change in Income (\(\Delta Y\))
Step 3: Detailed Explanation:
Given Data:
Initial Income (\(Y\)) = Rs. 80,000 Cr.
Change in Investment (\(\Delta I\)) = Rs. 7,000 Cr.
Marginal Propensity to Consume (MPC) = 0.50
Calculation for Multiplier (k):
\[ k = \frac{1}{1 - 0.50} = \frac{1}{0.50} = 2 \]
Calculation for (i) Increase in Income (\(\Delta Y\)):
\[ \Delta Y = k \times \Delta I \]
\[ \Delta Y = 2 \times 7000 = 14,000 \text{ Cr.} \]
Calculation for (ii) Total Income of the Economy:
\[ Y_{total} = Y + \Delta Y \]
\[ Y_{total} = 80,000 + 14,000 = 94,000 \text{ Cr.} \]
Step 4: Final Answer:
(i) The income will increase by Rs. 14,000 Crore.
(ii) The total income of the economy will be Rs. 94,000 Crore.