Thursday, August 27, 2009

Multiplier, its Concepts and Importance

EXPLANATION:

On OX axis income and OY axis investment and saving is shown. I is investment curve S is saving curve. II and SS curve intersect the investment and saving curve at point A. It shows that when income is 300 thousand and the aggregate saving and the aggregate investment is equal, if investment increases 3 to 4 thousand. Then saving and investment curve intersect at point “B”. An increase of one thousand investment increases 3 thousand national income. It is essential to explain here such diagram can also be used for negative effect.

ASSUMPTIONS:

1. No change in autonomous investment.

2. Induced investment is absent.

3. MPC remains constant.

4. Consumption is a function of current income.

5. No time legs in the multiplier process.

6. The new level of investment is maintained steadily for the completion of multiplier process.

7. There is net increase in investment.

8. Consumer goods are available in response to effective demand for them.

9. There is less than full employment level in the economy.

10. The accelerator effect of consumption on investment is ignored.

11. There are no changes in price.

12. There is closed economy.

13. Economy unaffected by the foreign influence.

14. There is an industrial economy in which the multiplier process operates.

15. Other resources of production are also easily available within the economy.

IMPORTANCE OF THE MULTIPLIER:

So far we have discussed the multiplier from the theoretical point of view. Now let us see its practical importance. These days governments actively interfere in the economic activity of the community. Therefore, it is essential to realise the importance of the multiplier in connection with investment, if there is depression and unemployment in the country, the people would like the government to undertake public works so that some employment should be provided to the unemployed. But if it is realised that an investment of Rs one crore will create employment worth many times, the importance of government investment will become clear. That is the multiplier principle has added to the importance of public investment when a country is engulfed in depression, the entrepreneurs are discouraged from investment, because in such a situation profit expectations are very low. Therefore if depression is to be lifted and the level of national income and employment is to be raised, it becomes necessary to increase public investment. If during such times, the government undertakes investment, the demand for consumer goods and hence the level of income and employment will increase manifold on account of the working of the multiplier. The operation of the multiplier rapidly removes depression through government investment and the economy moves towards full employment.

It is worth noting that when, owing to government investment to remove depression and unemployment the demand for goods and level of income and employment rises, the private entrepreneurs too are encouraged to invest. This happens because as the demand for goods increases and income rises owing to government investment, the profit expectations of the entrepreneurs go up and as a result the marginal efficiency of capital rises. Hence when government makes investment in public works to fight depression and unemployment, private investment is also encouraged on account of the operation of the multiplier. Depression is quickly lifted on account of investment both by the government and private entrepreneurs. If the multiplier did not operate, the increase in income and employment would not have been so much as when it operates. Influenced by Keynesian principle of the multiplier, the US government under took large-scale investment in public works to remove the great depression of 1929-34. This met with great success and depression was lifted.

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