The concept of multiplier is one of the most important contributions of Keynesian economics. It explains how an initial increase in investment leads to a more than proportionate increase in national income. The multiplier shows the relationship between change in investment and resulting change in income.
Multiplier refers to the ratio of change in income to the change in investment that brings it about.
It indicates that a small increase in investment can lead to a large increase in income.
Where MPC is marginal propensity to consume and MPS is marginal propensity to save.
The static working of multiplier assumes a constant marginal propensity to consume and no time lag in adjustment. It explains how an initial increase in investment leads to successive rounds of income generation.
When investment increases, it creates income for individuals. A part of this income is spent on consumption, which becomes income for others. This process continues in multiple rounds until the total increase in income becomes a multiple of the initial investment.
For example, if MPC is 0.8 and investment increases by ₹100, then total increase in income will be ₹500 (K = 5). Thus, income increases multiple times the initial investment.
Increase in investment leads to multiplied increase in income
Leakages are factors that reduce the effect of multiplier by decreasing the flow of income from one stage to another.
The multiplier explains how investment influences income and employment. Although it has limitations, it is a powerful tool in understanding economic fluctuations and policy making. Its effectiveness depends on the level of leakages in the economy.