PHILOSOPHY BEHIND KEYNESIAN INVESTMENT MULTIPLIER 1

KEYNESIAN INVESTMENT MULTIPLIER

KUMAR SARTHAK-1933323

1 ECOH A

CHRIST (Deemed to be University)

Bannerghatta Road Campus

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KEYNESIAN INVESTMENT MULTIPLIER

Every economic concept was developed by shaping a bunch of philosophical ideas. These

ideas are twirled and twined and applied to real life situations to formulate a theory and further

elaborate its applications. The concept of Investment Multiplier is one of the key concepts used

in the modern-day economics. The concept of multiplier was first proposed by F.A. Kahn in the

early 1930s. But eventually Keynes operated upon this idea to develop the investment multiplier.

Kahn developed it with reference to the increase in employment as a result of initial increase in

investment and employment. However, Keynes multiplier dealt with increase in total income as a

result of increment in initial investment and income. Thus, Keynes developed his theory of

income multiplier from the idea borrowed by Kahn’s theory of employment multiplier.

Keynes income multiplier mechanism suggested that heavy spending by the government,

consumers or the firms will have a remarkable impact in the national income of the economy.

Income multiplier shows the qualitative relationship between the final income and the rise in

investment which induces rise in income. It is assumed that the increase in income will be a

multiple of increase in investment. For example, if an initial investment of Rs. 100 crores is

made in the economy, and if the national income rises by Rs. 300 crores then the

investment/income multiplier will be 3.

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Kahn never used the term ‘multiple’ in his findings. But in late 1933, Keynes employed

this term ‘multiple’ in his ‘The Means to Prosperity’. Also, in response to his books, Keynes

published under another article ‘The Multiplier’ in ‘The New Statesmen and Nation’ which

clearly highlighted the use of this word. Harrod pointed out that Keynes has referred to the

concept of multiplier as mentioned in Kahn’s findings. This was how the concept of multiplier

was evolved as a refinement of the theory of Kahn’s employment multiplier in his Relation of

Home Investment to Employment published in 1931. (Wright,1956)1

Keynes examined the philosophy that whenever an investment is made in the economy,

the subsequent proceeds from spending that investment will lead to employment generation as

the investment proceeds would be used for some productive activity and will inflate the amount

of supply in the economy to meet the probable increased demand. Now, that employment and

production will generate income for both the producers who produce the goods and consumers

who consume the goods and services in the economy as a whole on a macro level which leads to

an increase in the national income. This all began with an initial increase in the investment which

aided multiplied increase in income, output, and employment.

The concept of income/investment multiplier is closely related to the Marginal Propensity

to Consume. The income multiplier establishes a very precise relationship between aggregate

income and the rate of investment given the marginal propensity to consume. The multiplier

model by Keynes denotes the total income creating effect of an autonomous investment based on

assumptions like the absence of time-lag, no induced investment, constant marginal propensity to

consume, closed economy, etc. (Hasan P.,1960)2

To understand the philosophy behind the working of investment multiplier, it is supposed

that the government invests Rs100 crores on various developmental schemes. This would
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remunerate various factors which will be involved in the developmental activity. Further

assuming that if the marginal propensity to consume is 70% then, people will spend 70% of the

income allocated to them. This 70% of income will actually now be the income for a different

group of people who in turn will spend 70% of that income earned. Thus, in this way, the initial

investment not only increases the income by Rs 100 crores but by multiples of that initial

investment due to re allocation of that investment in multiple cycles and reutilization of that

income. People tend to use their income for consumption which remunerates other groups and

multiplies the income. This phenomenon was observed by Kahn and framed properly in terms of

income later by Keynes. The larger the marginal propensity to consume, more will be the value

of multiplier. This is because as the aggregate demand increases, it accelerates the rate of

production which largely affects income, output and employment. Consumers are rational

consumers. If they have higher disposable income (which they received from the proceeds of the

increased investment) then it will induce the consumers to produce more output and hence

continue with the cycle of additional investment.

Thus, it is observed that how observations made by Keynes and his philosophical ideas

with respect to aggregate income led to the development of the investment multiplier. One large

investment in any sector induces secondary and tertiary consumption/investment but this cycle

cannot continue indefinitely. It finally comes to a halt when the additional investment made in

the induced round is not sufficiently high to generate a fresh income for the economy.

The value of investment multiplier by Keynes ranges from 1 to infinity. This is based on

the assumption that the value of MPC ranges from 0 to 1. For a practical multiplier, the value of

Marginal Propensity to Consume is more than 0 but less than 1. It is assumed that the consumer

definitely spends his income on consumption though it may be a small amount. Further it is also
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assumed that the consumer generally may not exhaust his money income so the value of MPC is

more than 0 but less than 1. Thus, multiplier ranges from 0 to infinity as per Keynes ideas.

The concept of multiplier is based on several assumptions like autonomous investment,

lump-sum taxes, availability of consumption goods, continuity of investment, positive net

investment, no time lag between consumption of successive goods, unemployed resources etc.

But in the present scenario, these assumptions as stated by Keynes do not hold perfect and so the

concept of investment multiplier suffers certain limitations. Some leakages like savings, debt

repayment, idle cash accumulation, imports slow down the work of the investment multiplier.

Thus, it can be concluded that the concept of investment multiplier was an add-on to the

idea of employment multiplier as proposed by Kahn and further developed with the philosophy

of Keynes. Investment multiplier does not only depict a magnified image of the effect of

increased investment but also it highlights the importance of investments in the economy. The

philosophy of Keynes has provided a solution to curb depression as increased investments will

lead to a growth in income, output and employment. Thus, this concept is very useful in today’s

economy for carrying out several economic decisions. (Poitras G.,2002)3

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Representation of Investment Multiplier

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References

1) Ll. Wright. (1956). The Genesis of the Multiplier Theory. Oxford Economic Papers, 8(2), new

series, 181-193. Retrieved from http://www.jstor.org/stable/2661731

2) Hasan, P. (1960). The Investment Multiplier in an Underdeveloped Economy. Economic

Digest, 3(4), 21-29. Retrieved from http://www.jstor.org/stable/41242973

3) Poitras, G. (2002). The Philosophy of Investment: A Post Keynesian Perspective. Journal of

Post Keynesian Economics,25(1), 105-121. Retrieved from

http://www.jstor.org/stable/4538814