Increase in income Rs. 2000 crore and MPC = 0.8. How much increase in investment?
₹400 crores
Understanding the Relationship Between Income, Investment, and MPC
This question asks us to determine the increase in investment needed to cause a specific increase in income, given the Marginal Propensity to Consume (MPC). This relationship is explained by the concept of the Keynesian multiplier in economics.
What is the Investment Multiplier?
The investment multiplier explains how an initial change in investment leads to a larger final change in national income. It's based on the idea that spending by one person becomes income for another, leading to a chain reaction of spending throughout the economy. The size of this multiplier depends on the Marginal Propensity to Consume (MPC), which is the proportion of an increase in income that a household spends.
The formula for the multiplier ($k$) is:
\( k = \frac{1}{1 - MPC} \)
Alternatively, the multiplier relates the change in income (\(\Delta Y\)) to the initial change in investment (\(\Delta I\)) as:
\( k = \frac{\Delta Y}{\Delta I} \)
Step-by-Step Calculation of Investment Increase
We are given the following information:
- Increase in Income (\(\Delta Y\)) = ₹2000 crore
- Marginal Propensity to Consume (MPC) = 0.8
We need to find the increase in investment (\(\Delta I\)).
Step 1: Calculate the Investment Multiplier
Using the formula \( k = \frac{1}{1 - MPC} \), we substitute the given MPC value:
\( k = \frac{1}{1 - 0.8} \)
\( k = \frac{1}{0.2} \)
\( k = 5 \)
So, the investment multiplier is 5. This means that every 1 rupee increase in investment leads to a 5 rupee increase in national income.
Step 2: Use the Multiplier to Find the Increase in Investment
We know that \( k = \frac{\Delta Y}{\Delta I} \). We have the value of the multiplier (\(k=5\)) and the increase in income (\(\Delta Y = 2000\)). We can rearrange the formula to solve for \(\Delta I\):
\( \Delta I = \frac{\Delta Y}{k} \)
Substitute the values:
\( \Delta I = \frac{2000}{5} \)
\( \Delta I = 400 \)
Therefore, the increase in investment required is ₹400 crores.
Conclusion
An increase in investment of ₹400 crores, with a Marginal Propensity to Consume (MPC) of 0.8, will lead to an increase in national income of ₹2000 crore.
| Item | Value |
|---|---|
| Increase in Income (\(\Delta Y\)) | ₹2000 crore |
| Marginal Propensity to Consume (MPC) | 0.8 |
| Investment Multiplier (\(k\)) | \( \frac{1}{1 - 0.8} = 5 \) |
| Increase in Investment (\(\Delta I\)) | \( \frac{\Delta Y}{k} = \frac{2000}{5} = 400 \) |
Revision Table: Key Economic Concepts
| Concept | Definition | Formula (where applicable) |
|---|---|---|
| National Income (Y) | The total value of goods and services produced in a country in a specific period. | - |
| Investment (I) | Spending on capital goods (like machinery, buildings) and changes in inventories. | - |
| Marginal Propensity to Consume (MPC) | The proportion of an increase in income that is spent on consumption. | \( MPC = \frac{\Delta C}{\Delta Y} \) |
| Marginal Propensity to Save (MPS) | The proportion of an increase in income that is saved. | \( MPS = \frac{\Delta S}{\Delta Y} \) |
| Relationship between MPC and MPS | MPC and MPS always add up to 1. | \( MPC + MPS = 1 \) |
| Investment Multiplier (k) | The ratio of the change in national income to the initial change in investment. | \( k = \frac{1}{1 - MPC} \) or \( k = \frac{1}{MPS} \) or \( k = \frac{\Delta Y}{\Delta I} \) |
Additional Information on the Multiplier Effect
The investment multiplier effect is a core concept in Keynesian economics. It demonstrates how changes in autonomous spending (like investment, government spending, or exports) can have a magnified impact on the overall level of economic activity and national income. The size of the multiplier depends inversely on the leakage from the circular flow of income, primarily saving (determined by MPS) but also taxes and imports in a more complex model.
For example, when investment increases by ₹400 crore, this becomes income for those involved in producing capital goods. If their MPC is 0.8, they will spend 80% of this extra income (₹320 crore), which becomes income for others. These others will then spend 80% of that income (₹256 crore), and so on. This process continues in rounds, with each round of spending being smaller than the last, eventually leading to a total increase in income that is the initial investment multiplied by the multiplier (₹400 crore * 5 = ₹2000 crore).
Understanding the investment multiplier is crucial for analyzing the impact of government policies like fiscal stimulus, as it helps economists estimate the potential boost to national income resulting from increased government spending or tax cuts that encourage investment or consumption.
Important Questions from Determination of Income and Employment
If the marginal propensity to consume is 0.8, the value of the investment multiplier will be:
Match List-I with List-II.
List-I List-II A. Income increases, Demand increases I. Complementary Goods B. Income increases, Demand decreases II. Substitute Goods C. Demand varies directly with the price of the related good III. Inferior Goods D. Goods consumed together IV. Normal Goods Choose the correct answer from the options given below:
If Marginal Propensity to Consume (MPC) is 0.75, what will be the value of Investment Multiplier?
Which of the following curve is graphically depicted by a 45° line passing through the origin?
Consumer behavior is influenced by the Marginal Propensity to Consume (MPC). Which of the following statements are correct?
A. Consumer may choose not to change consumption when income has changed then MPC = 0
B. Consumer may choose entire change in income then MPC = ∞
C. Consumer may choose not to change consumption when income has changed then MPC = 1
D. Consumer may choose entire change in income then MPC = 1
Choose the correct answer from the options given below:
