Define investment multiplier. How is it …

Investment Multiplier refers to increase in national income as i multiple of a given increase in Investment. Its value is determined by MPC. The value equals:

Multiplier = 1/1-MPC or 1/MPS

Suppose increase in investment is Rs.1000 and MPC = 0.8. The increase in National Income is in the following sequence.

(i) Increase in investment raises income of those who supply investment goods by Rs.1000. This is the first round increase.

(ii) Since MPC = 0.8, the income earners spend Rs.800 on consumption. This raises the income of the suppliers of consumption goods by Rs.800, This is second round increase.

(iii) In the similar way, the third round increase in Rs.640 = 800 x 0.8. In this way national income goes on increasing round after round.

(iv) The total increase in income is Rs.5,000 which equals.

△Y = △I x 1/1-MPC

△Y = 1000 x 1/1-0.8 = Rs.5000

Investment Multiplier = 1/1-MPC. It shows a direct relationship between MPC and the value of multiplier. Higher the proportion of increased income spend on consumption, higher will be the value of investment multiplier.