INVESTMENT

MULTIPKIER AND
ACCELERATOR
IQRA SALEEM
INTRODUCTION TO MULTIPLIER
The concept of Multiplier was first developed by R.F. Kahn in early
1930`s. He traced the effect of an increase in investment on
employment.

Then J.M. Keynes used it for income analysis. Keynes believe that an
increase in investment causes a much bigger increase in national
income
INTRODUCTION TO MULTIPLIER
When we change investment, it will bring a multiple change in
national income, but the question arise to what extent NI changes as a
result of change in investment.
Definition of Multiplier

An initial change in aggregate demand will lead to greater increase in the final level of
equilibrium National Income.

Multiplier shows that how an initial change in investment brings a multiple change in
income.

OR

Multiplier is the ratio of change in the National Income to a change investment.

EXAMPLE
The government decides to build new roads across the Afghanistan. They pay a
contractor $300m to do this. This creates a $300 million increase in spending in
the Afghan economy.
This will create a chain reaction of increases in expenditures.
The firm who gets the contract to build the roads will spend this $300m on
materials, equipment, wages & profits.
 This will create additional incomes for other firms and households.
 If they spend approx 60% of that additional income, then $180m will be added
to the incomes of others.
At this point, total income has grown by ($300m + (0.6 x $300m).
Example Cont.
The sum will continue to increase as the producers of the additional goods and
services gain an increase in their incomes, of which they in turn spend 60% on
even more goods and services.

The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x
$180m).

The process can continue indefinitely. But each time, the additional rise in
spending and income is a fraction of the previous addition to the circular flow.
 Size of Investment Multiplier...??
The final increase in national income (Y) will be greater than the
initial injection.

Marginal Propensity to consume determine the size of multiplier.

MPC = change in consumption/change in income

For example if the MPC is 0.8 it means 80% of the increase in income
is spent.
The investment multiplier is the direct function of marginal
propensity to consume (MPC).

The size of multiplier depends upon how large or small is the MPC.

If MPC is high, the value of the multiplier will also be high.

If MPC is small, the value of the multiplier will also be small.
The value of Multiplier can be obtained by following formula

For example if mpc is 0.80 then multiplier will be,

K = 1/ 1 – 0.8
K=5
OR

K = 1/ 0.2
K=5
Conclusion
The size of the multiplier depends on marginal
propensity to consume or propensity to save.

The larger the MPC, the larger the multiplier.

The larger the MPS, the smaller the multiplier.

Numerical Example for Multiplier
Action.
The investment multiplier tells us that an increase in investment brings about a multiple
increase in aggregate income.

Let us assume that MPC is 0.8 and an increase in investment is $100 mn.

The MPC being 0.8 means that the multiplier,

(K) = (1/1-0.8)

K=5

So the new investment of $100 mn will increase the aggregate income by $ 500 mn.
Assumptions of Multiplier
MPC is constant.

There is no changes in prices of commodities.

There is closed economy unaffected by foreign influence.

There is no change in autonomous investment

Accelerator Theory
The principle of acceleration states that if demand for consumption
goods rises, there will be an increase in the demand for factor of
production, say machine, which is used to produce the goods. In other
words, the accelerator measures the changes in investment goods
industries as a result of changes in consumption goods.
The accelerator theory was introduced by T.N. Carver in 1903 and
J.M. Clark in 1917.

The accelerator theory explains the interrelationship between

customer goods industries and capital goods industries in an
economy.
The Principle of Acceleration
The principle of acceleration is based on the fact that demand for
capital goods is derived from the demand for Consumer goods, it
means that if there is demand of consumer goods in market,
investment will take place and demand for capital goods will
increase.
The Principle of Acceleration
Acceleration principle explains the process by which an increase or
(decrease) in demand for consumption goods leads to an increase or
decrease in investment or capital goods.

In words of Kurihara “ acceleration coefficient is the ratio between

induced investment and initial change in consumption expenditure.
This means that when the income of a community rises the
purchasing power of the people increases. They begin to buy more
commodities. The higher the demand for consumer goods leads to
greater investment. The rise in investment is proportionately more
than the rise in demand for consumption.
According to Samuelson, accelerator (v) is as defined the ratio of
change in investment to the change in consumption demand ,i.e.
V = ∆I/∆C
Where,
V = Accelerator coefficient
∆I = Change in investment outlays
∆C = Change in Consumption demand
∆I = v ∆C
Example
If the increase in consumption expenditure of Rs 10 crores
leads to an increase in investment of Rs 30 crores, the
accelerator coefficient is 3.