Multiplier

Concept of Multiplier
• First developed by Prof R.F. Khan
• Keynes developed from him and formulated as
Investment Multiplier
• Investment Multiplier – When there is an
increment in investment, income will increase
by an amount which is K times the increment
of investment i.e., ∆Y = K∆I
• The value of multiplier is determined by MPC
• Higher the MPC, higher is the value of
multiplier and vice versa
• K= 1/1-c, where, c = MPC
• K= 1/MPS (MPC+MPS=1)
• MPC is always greater than 0 and less than 1
• Multiplier is between 1 and infinity
• If multiplier is 1 and MPC is 0 = whole income
is saved and nothing is spent
• If multiplier is infinity and MPC is 1 = whole
income is spent on consumption
 Importance of Multiplier
• Income Propagation: concept of multiplier tells us that income propagation is a
natural process. It tells that increase in employment, income and output is due to
increase in investment
Importance of Investment: it is the initial increase in the investment that results in
multiple increase in income .
Trade Cycles: trade cycles are those cycles which tell business fluctuations take
place over a period of long run. Sometimes there is a boom and at another time
there is depression in business. So multiplier helps in understanding trade cycles
Full Employment: Multiplier’s concept is of great importance while formulating
policy regarding full employment. it shows that to attain full employment situation
a thrust of net investment should be made in the economy .
Deficit Financing: deficit financing helps in removing bad effects of depression. it is
so because as a result of deficit financing investment increases and increase in
investment causes multiple increase in income in terms of multiplier effect.
 Criticism
• The assumption of multiplier that MPC is less than unity
and remains constant is wrong ; because, in fact,
Relationship between income and consumption is not so
simple as is assumed by Keynes.
• Effect of Acceleration is Ignored: it does not take into
consideration, change in investment as a result of change
in consumption.
• In fact, multiplier is influenced not only by investment but
also by consumption expenditure. if consumption
expenditure is increased, the multiplier will continue to
work, although no investment is undertaken.
• Debt Cancellation:
• It has been observed that part of the income
received by the people in the economy may
be used for paying off old debts to the banks
and individuals, who may, in turn, fail to
spend. As such, the consumption is not
stimulated and the value of the multiplier is
thereby reduced.
• Price Inflation:
• Price inflation constitutes another important leakage
from the income stream of an economy. As long as
there is unemployment of resources and factors of
production, increase in investment will have
expansionary effects. But once that full employment
or near full employment of the resources has been
attained, increase in investment will go to raise
prices and the cost of the factors of production
• Hoarding:
• Hoarding or the tendency of the people to
hold idle cash balances forms another leakage.
If the people have high liquidity preference
and a tendency to keep idle cash balances
they will diminish the expenditure on
consumption in the economy, thereby
restricting the value of the multiplier.
• Purchase of Stocks and Securities:
• Sometimes, people purchase old stocks and
securities with the newly created income and
do not spend it on increased consumption.
Some of them purchase new insurance
policies. 
 Will Multiplier work in an under-developed
or developing country?
• For the working of multiplier in raising
national income and employment, the supply
of raw materials, financial capital must be
sufficiently elastic so that when aggregate
demand increases as a result of multiplier
effect of increase in investment the supply of
output could be increased adequately to meet
this higher demand for goods and services.
• In underdeveloped countries like India due to
under-developed nature of their economies,
there was acute scarcity of raw materials,
other intermediate goods such as steel,
cement and financial capital which put great
obstacles for the working of multiplier in 
• There is only the presence of disguised
unemployment and not involuntary
unemployment in such countries
• They could not be shifted to industries to
increase output
•  It was pointed out that the under-developed
countries like India had predominantly
agricultural economies and income elasticity
of demand for food-grains was very high in
these economies. In view of this when
increase in investment leads to the rise in
money incomes of the people, a large part is
spent on food-grains.
• But the supply of agricultural products is
inelastic because their production is subject to
natural calamities and there is lack of
irrigation, seeds, fertilisers, etc.
• Hence it is difficult to increase agricultural
production in response to increase in demand
through multiplier effect of increase in
investment