21

THE CHANGE IN AGGREGATE DEMAND AND

THE MULTIPLIER

In the preceding sections, we have explained the Keynesian theory of income and output determination
in a simple two-sector model. It may be inferred from the income determination analysis that
a change in aggregate spending will shift the equilibrium from one point to another and a shift in

the equilibrium will reflect change in the level of national income. An increase in aggregate spending
makes the aggregate demand schedule shift upward. As a result, the equilibrium point would shift
upward along the AS schedule causing an increase in the national income. Likewise, a fall in the
aggregate spending causes a fall in the national income. This relationship between the aggregate
spending and the national income is simple and straightforward. However, our analysis so far tells
us only the direction of change in the national income resulting from the change in the aggregate
demand. It does not quantify the relationship between the two variables, i.e., it does not tell us the
magnitude of change in the national income due to a given change in the aggregate spending.

The two specific questions that need to be answered are: (i) Is there any specific relationship
between the change in aggregate demand and the change in the national income? and (ii) If yes,
then what determines this relationship and the magnitude of change in the national income? The
answer to these questions is provided by the theory of multiplier. The theory of multiplier occupies
a very important place in the analysis of national income behaviour in response to the changes in
its determinants. It is also an important tool to analyse the effects of changes in the monetary and
budgetary policies of the government.
Before we begin our discussion on the multiplier theory, let us note that a shift in the aggregate
demand in a modern economy may be caused by the change in business investment, government
spending, taxes, export and import. Accordingly, we have investment multiplier, government expenditure
multiplier, tax multiplier, balanced budget multiplier, fiscal multiplier, export multiplier and
import multiplier. In this section, we are concerned with change in aggregate demand due to change
in business investment and investment multiplier