11 11-2020 lecture
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The document discusses the concept of the multiplier, which was originally developed by F.A. Kahn in the 1930s to analyze how an initial increase in investment leads to further increases in income and employment through subsequent rounds of spending. It describes how Keynes later refined the multiplier concept. It provides equations to calculate the multiplier based on the marginal propensity to consume. It also discusses limiting cases when the MPC is 1 or 0 and factors that can cause "leakages" from the multiplier process, reducing its effectiveness. Finally, it distinguishes between the static and dynamic multiplier models.
11 11-2020 lecture
- 1. MULTIPLIER
- 6. Concept of Multiplier • The concept of multiplier was first of all developed by F.A. Kahn in the early 1930s. • But Keynes later further refined it. • F.A. Kahn developed the concept of multiplier with reference to the increase in employment, direct as well as indirect, as a result of initial increase in investment and employment.
- 7. Concept of Multiplier • Kahn gave the Employment Multiplier • Keynes gave the Investment Multiplier
- 8. Concept of Multiplier • ΔY = ΔI 1/1-MPC • ΔY/ΔI = 1/1-MPC • ΔY/ΔI measures the size of the multiplier. Therefore, • Size of multiplier or k = 1/1-MPC
- 9. Concept of Multiplier • The multiplier can be derived algebraically as follows: • Writing the equation for the equilibrium level of income we have Y = C + I (1) • As in the multiplier analysis we are concerned with changes in income induced by changes in investment, rewriting the equation (1) in terms of changes in the variables we have ΔY = ΔC + ΔI (2)
- 10. Concept of Multiplier • In the simple Keynesian model of income determination, change in investment is considered to be autonomous or independent of changes in income while changes in consumption are function of changes in income.
- 11. Concept of Multiplier • In the consumption function, C = a + bY where a is a constant term, b is marginal propensity to consume which is also assumed to remain constant. Therefore, change in consumption can occur only if there is change in income.
- 12. Concept of Multiplier • Theory of Multiplier ΔC = bΔY (3) • Substituting (3) into (2) we have ΔY = bΔY + ΔI ΔY – bΔY = ΔI ΔY (1 – b) = ΔI Or ΔY = 1/1-b ΔI ΔY/ΔI = 1/1 -b • As b stands for marginal propensity to consume ΔY/ΔI = 1/1 – MPC = 1/MPS
- 13. POLL The concept of multiplier was first developed by a. J M Keynes b. F A Khan c. J D Clark d. Samuelson
- 14. Two Limiting Cases of the Value of Multiplier If Marginal Propensity to Consume = 1, that is, when the whole of the increment in income is consumed and nothing is saved. In this case, the size of multiplier will be equal to infinity, that is, a small increase in investment will bring about a very large increase in income and employment so that full employment is reached and even the process goes beyond that.
- 15. Two Limiting Cases of the Value of Multiplier • “In such circumstances, the Government would need to employ only one road builder to raise income indefinitely, causing first full employment and then a limitless spiral of inflation.”
- 16. Two Limiting Cases of the Value of Multiplier • The other limiting case occurs when marginal propensity to consume is equal to zero, that is, when nothing out of the increment in income is consumed, and the whole increment in income is saved.
- 17. Leakages in Multiplier • In words of Peterson ,” Income that is not spent on currently produced consumption goods and services may be regarded as having leaked out of income steam .” • The more powerful these leakages are ,the smaller will be the value of multiplier.
- 18. Important Leakages • Idle saving :leads to equivalent fall in marginal propensity to consume . • Results into fall in the value of multiplier. • As a matter of fact, higher the MPS greater is the leakage from income propagation and smaller is the value of multiplier.
- 19. Important Leakages • Purchase of govt.: securities and shares : • when some part of increased income is used to purchase old shares and govt. securities means this part of income is not spent on consumer goods . Consequently , the flow of income stream falls.
- 20. Important Leakages • Paying of old debts :That part of increased income which is utilised in paying of old debts is obviously not spent on consumption .This leakage also constricts the process of income generation . • Import: liquidity drains out of the system equivalent to the value of imports through which propensity to consume falls limiting the multiplier effect of increased investment .
- 21. Important Leakages • Excess stock of consumption goods: increase in income leads to increase in consumption . • If the increased demand for consumer goods is met out of the existing stocks ,means new consumer goods are not produced that results into hampering the growth of multiplier.
- 22. POLL The balanced budget multiplier in the Keynesian Cross Model is a. Equal to one. (b) greater than one. (c) less than one d. None of these
- 23. Important Leakages • High liquidity Preference: it means if people want to hold more money in cash for transaction, precautionary and speculative motives, it would imply less expenditure also serves as a leakage of multiplier. • Price Inflation: under inflationary situation people have to spend more money to buy same amount of goods and services as before. The effect is that there will be not much increase in level of consumption and ultimately multiplier effect will remain limited.
- 24. Important Leakages • Taxation system : if taxes on goods and progressive taxes on income are increased ,there will be no appreciable increase in consumption despite increase in income . As a result process of income propagation slows down .
- 25. Important Leakages • Undistributed profits of companies : Many companies do not distribute all the profits among the shareholders; as they keep a part of it as a reserve fund. The undistributed profits also serves as a leakage of the multiplier because this amount is not made available to the shareholders who could use it as a consumption expenditure
- 26. Dynamic Multiplier • Keynes's logical theory of the multiplier is an instantaneous process without time lag. • Static equilibrium analysis in which the total effect of a change in investment on income is instantaneous so that consumption goods are produced simultaneously and consumption expenditure is also incurred instantaneously
- 27. Dynamic Multiplier • "the timeless multiplier analysis disregards the transition and deals only with-the new equilibrium income level" and is, therefore, unrealistic.
- 28. Dynamic Multiplier • The dynamic multiplier relates to the time lags in the process of income generation. • The series of adjustments in income and consumption may take months or even years for the multiplier process to complete, depending upon the assumption made about the period involved.