WHY IS INVESTMENT MULTIPLIER DIRECTLY PROPORTIONAL TO MPC
Investment multiplier implies that any change in the investment leads to a corresponding change in the income and output by multiple times.
Algebraically, investment multiplier is expressed as a ratio of the change in output to the change in investment. That is,
There exists a direct and positive relationship between Investment Multiplier and MPC. Algebraically, the relationship is expressed as:
That is, higher the value of MPC, higher will be the value of multiplier and lower the value of MPC, lower will be the value of multiplier.
Higher value of MPC implies that higher will be the consumption expenditure with each round of increase in income in the multiplier process. This higher consumption expenditure then further leads to higher income in the successive round and so on.
Suppose, the value of MPC is 0.5 then , the value of multiplier is
On the other hand suppose the value of multiplier is greater than 0.5 say, 0.8 then, the value of multiplier is
Thus, we see that as the value of MPC increases from 0.5 to 0.8, the value of multiplier increases from 2 to 5.