KEYNES'S THEORY OF INVESTMENT MULTIPLIER

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MACROECONOMICS

KEYNES'S THEORY OF INVESTMENT MULTIPLIER

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INVESTMENT MULTIPLIER Keynes concept of investment multiplier shows relationship between investment and income. According to him an initial increase in investment creates larger increase in final aggregate income. This multiplier effect works through increase in consumption expenditure. Investment multiplier is thus a ratio of an increment in final income to an initial increment in investment.

                         ∆ Y

K =

                         ∆ I

where K = Coefficient of multiplier

        ∆ I  =  Increase in initial investment  
       ∆ Y  =   Increase in national income

By rearranging, it can be written as ∆ Y = K ∆ I

Thus, when there is an increment of investment, income will increase by an amount which is K times the increment of investment. The value of multiplier coefficient is determined by the marginal propensity to consume (MPC). Thus,

                  1

K =

            1 - MPC

The following diagram shows the multiplier effect.