ELEMENTARY THEORY OF THE MULTIPLIER. The theory of the multiplier states that an increase in consumer or business investment spending in a country would produce a multiplier effect by raising the level of national income. In other words, the multiplier is the figure by which an increase on total expenditure in the country may be multiplied to get the resulting increase in the national income.
What is income multiplier?
The multiplier is also referred to as the ration of changes in national income to changes in the autonomous expenditure which led to it.
The multiplier effect cab be as a result )f changes in consumption expenditure, which is known as consumption multiplier, or investment changes, which is known as investment multiplier.
Using the investment multiplier as an example if a M3million increase in total investment in a country leads to a M9million increase in national income, the multiplier is therefore equal to three.
The multiplier is a system used in all types of spending in a country by individuals, firms and the government.
The multiplier, denoted by K, is usually calculated with the aid of a formula:
- K = 1 = 1
1 – MPC MPS
- K = DY
DC or 1
K = Multiplier
MPC = Marginal Propensity to Consume
MPS = Marginal Propensity to save
Y = Change in national income
C = Consumption Expenditure
I = Investment
A knowledge of the marginal propensity to consume or the marginal propensity to save helps us to know the multiplier. And a knowledge of the multiplier helps us to know the extent to which consumption expenditure on investment should be increased or decreased to achieve a desired level of income.
The higher the MPC, the higher the multiplier effect and the higher the MPS, the lower the multiplier effect. Therefore, a higher MPC increases national income while a higher MPS will reduce it.
Suppose the MPC is 0.75. This means that 0.75 of every additional income will be consumed. The amount saved will be 1- 0.75 = 0.25, since MPC + MPS = 1
The multiplier, the MPC and MPS are related by the formula:
K = 1
1 – MPC
Since 1 – MPC = MPS, this implies that
K = 1 Where K is the multiplier
- If the marginal propensity to consume is 0.8, calculate the multiplier
- By how much must consumption expenditure be increased to increase income by N10,000.00
K = 1 = 1
1 – MPC 1 – 0.8
The multiplier K has a value of 5
b. K = ∆Y
4 = N10,000.00
4C = N10,000.00
C = N2,500.00
If the marginal propensity to consume is 0.75, by how much will national income increase if government expenditure is increased by 68million?
- K = 1 = 1
1 – MPC 1 – 0.75
K = ∆Y
4 = ∆Y
DY = N8m x 4
DY = N32m
The national income will increase by N32million which is an example of the theory of the multiplier
When government investment changed from N500m to N800m, the marginal propensity to consume was 0.6. Determine the changes in national income level.
∆Y = 1
∆I 1 – MPC
∆Y x 1 – MPC = ∆I
∆Y = ∆1
1 – MPC
∆Y = N800m – N500m
1 – 0.6
∆Y = N300m
∆Y = N750m
Changes in national income level is N750m