Question

State the relation between Multiplier and Marginal propensity to Consume.

Hint:

Multiplier is also inversely related to the Marginal Propensity to Save (\( MPS \)) because \( k = \frac{1}{MPS} \). If you save more (high \( MPS \)), the multiplier effect leaks away.

Answer 1

Step 1: Understanding the Concept:
The Investment Multiplier measures the ratio of the change in National Income to the initial change in Investment. It explains how an initial injection of spending leads to a much larger increase in final income.
Step 2: Key Formula or Approach:
The relationship is expressed by the formula:
\[ k = \frac{1}{1 - MPC} \]
Step 3: Detailed Explanation:
- If people spend a larger portion of their extra income (\( MPC \) is high), the money circulates more in the economy, creating more income for others.
- Example 1: If \( MPC = 0.5 \), then \( k = \frac{1}{1-0.5} = 2 \). An investment of ₹100 leads to an income increase of ₹200.
- Example 2: If \( MPC = 0.8 \), then \( k = \frac{1}{1-0.8} = 5 \). An investment of ₹100 leads to an income increase of ₹500.
Thus, as \( MPC \) increases, the multiplier effect becomes stronger.
Step 4: Final Answer:
The value of the multiplier depends directly on the \( MPC \); a higher propensity to consume leads to a higher value of the multiplier.