Question

Suppose for an economy, the government proposes a project for the construction of expressways with an incremental investment of ₹1,200 crore. Assuming 80% of the increase in income is spent on consumption. Estimate the following on the basis of the above information:

• Change in income (\(\Delta Y\))
• Change in consumption (\(\Delta C\))

Hint:

The multiplier effect amplifies the impact of government investment on the economy, with a higher MPC leading to a greater change in consumption.

Answer 1

Given: - Incremental Investment = ₹1,200 crore - 80% of the increase in income is spent on consumption We can use the concept of the Marginal Propensity to Consume (MPC), which is given as 0.8 (or 80%). To estimate the change in income and consumption, we can follow these steps: \[ \text{Multiplier} = \frac{1}{1 - \text{MPC}} = \frac{1}{1 - 0.8} = 5 \] (a) Change in Income (\(\Delta Y\)): The change in income is the total increase in income due to the investment. Since the multiplier is 5, the total change in income is: \[ \Delta Y = \text{Multiplier} \times \text{Incremental Investment} = 5 \times 1200 = ₹6,000 \text{ crore} \] (b) Change in Consumption (\(\Delta C\)): The change in consumption is the part of the increase in income that is spent. Since 80% of the increase in income is spent on consumption, we calculate: \[ \Delta C = \text{MPC} \times \Delta Y = 0.8 \times 6,000 = ₹4,800 \text{ crore} \] So, - The change in income (\(\Delta Y\)) is ₹6,000 crore. - The change in consumption (\(\Delta C\)) is ₹4,800 crore.