The concept of multiplier was introduced by Keynes to explain how an increase in investment leads to a multiplied increase in income. While the static multiplier explains this process in a simplified manner, the dynamic multiplier considers the time element and explains how income increases gradually over time through successive rounds of expenditure.
Dynamic multiplier refers to the process through which an initial increase in investment leads to successive increases in income over a period of time, rather than instantaneously.
It recognizes that the adjustment process takes time and occurs in different stages.
In the dynamic process, when investment increases, it creates income for individuals in the first round. A portion of this income is spent on consumption, which becomes income for others in the second round. This process continues in multiple rounds over time.
Each round of expenditure generates less additional income than the previous round because a part of income is saved. Eventually, the process converges to a final level of income determined by the multiplier.
Unlike the static multiplier, which assumes immediate adjustment, the dynamic multiplier shows that income increases gradually and reaches equilibrium after several periods.
Income increases gradually over time due to multiplier effect
However, the effectiveness of multiplier in developing countries is limited due to factors like high marginal propensity to import, lack of infrastructure, and leakages such as savings and taxation.
The dynamic multiplier provides a more realistic explanation of how income increases over time through successive rounds of expenditure. It is an important tool in understanding economic growth and policy making, especially in developing countries. Despite its limitations, it remains a key concept in macroeconomics.