Investment Expenditure and The Multiplier

Expenditure on investment goods constitutes part of aggregate expenditure. If investment expenditure is increased, there will be an increase in national income which is greater than increase in investment expenditure. On the other hand, a reduction in the level of investment will reduce income by a higher proportion compared with the proportion by which investment is reduced.

Multiplier (k) = 1/ 1- MPC = 1/MPS =   Δ Y/  Δ I.

Example

If the marginal propensity to save is 0.5, calculate:

1. The Multiplier
2. The level of investment which in required to raise income by N3000.00

Solution:

K = 1/MPS = 1/ 0.5 =2

K =    Δ Y/  Δ I

2= 3000/ I

2I = N3000.00

I = N3000.00 / 2 =N1500.00

Government expenditure and the multiplier

As with private consumption and investment, expenditure by government has multiplier effects on the national income.

Increased government spending increases national income at an increasing rate, while a reduction in government spending will have a reverse effect.

K = 1/ 1 – MPC   = 1/MPS   =     Δ Y/ Δ G

Example: If the marginal propensity to consume is 0.6, by how much will national income increase, if government expenditure is increased by N4000.00?

Solution

K = 1/ 1 – MPC   =1/ 1 – 0.6   =1/ 0.4   =2.5

K =   Δ Y/ Δ G

2.5 =      Δ Y / N4000

Δ Y = N4000.00 X 2.5

= N10000.00