Thursday, August 27, 2009
Limitations and Leakages of Multiplier
LIMITATIONS OF MULTIPLIER:
On theoretical plane, the multiplier principle seems to be very attractive, but in actual practice things may not materialise as desired. Its working is subject to several limitations.
(i) Efficiency of Production: If the production system of the country can not cope with increased demand for consumption goods and make them readily available, the incomes generated will not be spend as visualised. As a result the marginal propensity to consume may decline.
(ii) Regular Investment: The value of the multiplier will also depend on regularly repeated investments. A steadily increasing investment is essential to maintain the tempo of economic activity.
(iii) Multiplier Period: Successive doses of investment must be ignored be injected at suitable intervals if the multiplier effect is not be lost.
(iv) Full employment ceiling: As soon as full employment of the idle resources is achieved, further beneficial effect of multiplier will practically cease.
2. LEAKAGES OF THE MULTIPLIER:
The following are the principal leakages of the multiplier.
(i) Paying off Debts: It generally happens that a person has to pay a debt to a bank or to another person. A part of this income goes out in repaying such debts and is not utilized either in consumption or in productive activity. Income used to pay off debts disappears from the income stream. If, however, the creditor uses this amount in buying consumer goods or in some productive activity, then this sum will generate some income, otherwise not.
(ii) Idle Cash Balances: It is well known that people keep with them ready cash which is neither used productivity nor in purchasing consumer goods. Keynes has mentioned three motives for holding ready cash for liquidity preferences viz transaction motive, precautionary motive and speculative motive. This means that the respent part of income goes on decreasing. In this way, a part of the initial expenditure leaks out of the income stream. The cash may be kept in current account for saving account. But it is kept away from the expenditure all right, it would have otherwise added, to the future income.
(iii) Purchase of old Stocks and Securities: If a part of the increased income is used in buying old stock and securities instead of consumer goods, the consumption expenditure will fall and its cumulative effect on income will be less than before.
(iv) Price Inflation: When increased income investment leads to price inflation the multiplier effect on increased income may be dissipated on higher price.
(v) Net Imports: If increased income is spent on the purchase of imported goods it acts as leakage out of the domestic income stream. Such expenditure fails to affect the consumption of domestic goods.(vi) Undistributed Profits: If undistributed profit of joint stock companies not distributed to share holders in the form of dividend but are kept in reserved fund it is a leakage from income stream and the multiplier process will be arrested. Tags: Macro Economics
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