Investment multiplier

Investment Multiplier

1. Investment Multiplier (Keynesian Investment Multiplier) In simple term the multiplier is something that multiplies or increases. In economics particularly in macroeconomics the multiplier is the change in output that results from one unit change in autonomous expenditure. Investment Multiplier asserts that an increase in private consumption expenditure, investment expenditure, or net government spending raises the total  Gross Domestic Product ( GDP) by more than the amount of the increase. 

2. The belief of Keynesian multiplier is that if investment increases there will be an increases in output due to the multiplier relationship between equilibrium output and autonomous expenditure . According to Kurihara – “The multiplier is the ratio of change in income to the change in investment.” k = where k = investment multiplier ; Δ Y= change in income/output ; Δ I = change in investment  

3. Assumptions Constant Price Level – no change in the price of the commodities and price of raw materials. Less than full employment No shortage of factor resources No time lag – no time lag between receipts of income and its spending Autonomous Investment – effect of interest rate is neutral in the economy

4. Derivation of Simple Keynesian Investment Multiplier We know that equilibrium occurs when Y = AD Y = C + I, ………….( i ) the relationships holds true when there is change in variables Δ Y = Δ C + Δ I……………(ii) dividing both side of equation (ii) by Δ Y, = + ……….(iii) 1= + by the definition we know that = MPC  

5. continued 1 = MPC + 1 - MPC = = ……………..(iv) From equation (iv) we can say that there is direct and positive relation between size of multiplier and MPC . It shows that higher the MPC higher the k and vice versa. Furthermore we can write the equation (iv) as given below, = ……………..(v) From equation (V) we can say that there is inverse relationship between size of multiplier and MPS.