Explain with the help of a numerical example, how an increase in investment in an economy affects its level of income.
Increase in investment in an economy generates a multiplier effect on its. National Income. The extent of multiplier effect (and therefore, the extent of total increase in income) depends on the Marginal Propensity to Consume (MPC). Higher the MPC, greater would be the multiplier effect and vice-versa. Let us assume that:
(i) Increase in investment (∆I) = Rs. 1000 crore
(ii) MPC = 0.5
Increase in Income (∆Y) = K. ∆I,
where, K = Multiplier
K = 1 /1 — MPC = 1 /1-0.5 = 2
Accordmgly, K = ∆Y / ∆I = 2 = ∆Y / 1000
∆Y = 2 x 1000 = Rs.2000 crore