Mpc and multiplier relationship

The multiplier effect

mpc and multiplier relationship

The Multiplier Effect is the change in income to the permanent change in the MPC – Marginal Propensity to Consume – it is the increase in. its relationship with MPC. The concept of 'Investment Multiplier' is an important contribution of Prof. J.M. Keynes. Keynes believed that an initial. In economics, the marginal propensity to consume (MPC) is a . The relationship between the multiplier and the propensity to consume is as follows: Y = C + I {\ displaystyle Y=C+I} Y=C+I: Δ Y = Δ.

And the person to really spend it with is the farmer. Now given this assumption, let's think about what would happen in this economy if all of a sudden one of them decided to increase their spending a little bit. So we'll assume that they were all living happily. The economy was kind of at a steady state. And let's say the farmer discovers a sock in a drawer that he didn't realize was there.

And it's got a little bit of their agreed upon currency. Maybe the agreed upon currency in this island is a dollar. They've maybe got a stash when their shipwrecked on this, or whatever.

Answers and Solutions

So the agreed upon currency is actually the dollar. And the farmer discovers that he's got-- he discovers a big pile of dollars in his sock. I need to do some repairs to my buildings. So we have this kind of increase in spending that's going on. So he's going to spend, and the only person he can spend it with is the farmer.

Somehow the economy seems to be picking up. He bought that much more food. I have a marginal propensity to consume of 0. So it will be I'll write it as a decimal-- it'll be 0.

So he's going to spend 0. I don't know, I could get a calculator to figure out what that is exactly. So let's say that I have 0. Or let's just write that-- 0. And I think you see where this is going.

So it's going to be-- I'll write it here-- it's going to be 0. So you're going to have 0. That's going to be 0. And I'll just calculated it. And it goes on and on and on. So the way to think about that, so the total-- and we could view it either way. Remember, you could view kind of the GDP. You could view that as the aggregate output. You could view that as the aggregate income, aggregate expenditure. These are all views because really the economy is a very circular thing.

One person's expenditure turns into another person's income.

mpc and multiplier relationship

But we could say total output here, measured in our agreed upon currency, which is let's say dollars. Remember, the value of multiplier determines the rate of growth in the economy A higher value of multiplier will attain a higher level of income and growth.

Marginal propensity to consume - Wikipedia

This can be further clarified with the help of an example. Mind, multiplier works through consumption. Suppose, government invests Rs crore in establishment of a fertilizer factory.

The first impact of this new investment will be that the income of employees engaged in this factory will go up by Rs crore. This is not the end of the story. The producers of these goods will have an extra income of Rs 75 crore. The process of increase in income stops when change in income becomes equal to change in saving.


The process of working of multiplier is further illustrated in the following table. The above table clearly shows that Initial increase in investment of Rs crore has resulted in an increase of additional income of Rs crore, i. Keeping in view the significance of concept of investment multiplier, Keynes suggested that in the situations of unemployment and depression, government should Increase volume of its investment in public utility works to give quick start to economy.

Graphic Presentation of Multiplier: The effect of multiplier can be illustrated with the help of the following graphical Fig.

mpc and multiplier relationship

Here OX measures national income and OY saving and investment. At the equilibrium point of E, saving and investment are equal and income is Rs crore.

At the new equilibrium point E1, national income is Rs crore.