In economic theory, a multiplier is a category used to define and characterize relationships where there is a multiplier effect. World renowned economist J. M. Keynes, the author of macroeconomic theory, called the multiplier a coefficient that characterizes the dependence of changes in income on changes in investment.
Instructions
Step 1
According to Keynes's theory, any increase in investment triggers a multiplicative process, which is expressed in an increase in the level of national income by a greater amount than the initial growth in investment. Keynes called this effect the multiplier effect. k (multiplier) = income growth / investment growth. The strength of the multiplier effect depends on the marginal propensity to save and consume. If the values of these indicators are relatively constant, then it will not be difficult to determine the multiplier.
Step 2
To calculate the multiplier, assume that:
I - investments; C - consumption; Y is the national income; MPS is the marginal propensity to save and MPC is the marginal propensity to consume.
Step 3
Since Y = C + I, the increase in income (Y) will be equal, respectively, to the sum of the increase in consumption (C) and the increase in investment (I).
Step 4
According to the formula of the marginal propensity to consume: MPC = C / Y, we get: C = Y * MPC.
Substitute this expression in the above equation (Y = C + I).
We get: Y = Y * MPC + I.
Therefore: Y * (1 - MPC) = I.
Step 5
Further: an increase in income Y = (1/1 - MPS) * an increase in investment I, but since k = an increase in Y / an increase in I, therefore an increase in Y = k * an increase in I. This means that k = 1/1 - MPS = 1 / MPS, where k is the investment multiplier.
Step 6
Thus, the investment multiplier is the reciprocal of the marginal propensity to save. The multiplier acts both forward and backward.
