The following certain essential conditions for the operation of
multiplier include:
The supply
curve of output should be elastic. When
demand for certain goods or services expand, its supply can be enlarged without
much inconvenience.
There is excess productive capacity in consumer
goods industries, so that the supply of goods can be conveniently increased
when demand expands. The supply of raw materials and working capital
should also be elastic. There should be ‘involuntary unemployment’. This implies that there are people who want
work at the prevailing wage rate, but are not obtaining work.
Limitations of Multiplier: The multiplier suffers from the following limitations.
Limitations of Multiplier: The multiplier suffers from the following limitations.
1. Efficiency
of production:
The mpc may decline if the production system of the country cannot cope with increased demand for consumption goods and make them readily available the income generated will not be spent as visualized.
The mpc may decline if the production system of the country cannot cope with increased demand for consumption goods and make them readily available the income generated will not be spent as visualized.
2. Regular
investment:
A steadily increasing investment is essential to maintain the pace of economic activities. So the value of the multiplier to an extent will depend on regularly repeated investments.
A steadily increasing investment is essential to maintain the pace of economic activities. So the value of the multiplier to an extent will depend on regularly repeated investments.
3. Multiplier
period:
In order to maintain the multiplier effect successive doses of investment must be injected at suitable intervals.
In order to maintain the multiplier effect successive doses of investment must be injected at suitable intervals.
4. Full
employment ceiling:
As soon as full employment of the idle resources is reached, additional beneficial effect of the multiplier will practically cease.
5. Leakages of Income Stream and Their Effect on the Multiplier:
You might be aware that as income goes up, consumption does not increase to the same extent because income is partially saved. The part of the income that is saved is considered as a leakage from the flow of income stream. These leakages hinder the growth of national income. If these leakages do not occur, mpc would have been equal to one. The consumption expenditure would have increased 100 per cent of the increase in income and there would be a situation of full employment.
The following are the major leakages from the income stream.
As soon as full employment of the idle resources is reached, additional beneficial effect of the multiplier will practically cease.
5. Leakages of Income Stream and Their Effect on the Multiplier:
You might be aware that as income goes up, consumption does not increase to the same extent because income is partially saved. The part of the income that is saved is considered as a leakage from the flow of income stream. These leakages hinder the growth of national income. If these leakages do not occur, mpc would have been equal to one. The consumption expenditure would have increased 100 per cent of the increase in income and there would be a situation of full employment.
The following are the major leakages from the income stream.
(a) Paying off debts:
It generally happens that a person has to pay a debt to a bank or to another person. A portion of his income goes out in repaying such debts and is not employed either in consumption or in productive area. Income used to pay off debts runs out of the income stream. If the creditor spends this amount in purchasing consumer goods or in some productive activity this amount will generate some income otherwise not.
(b) Idle cash balances:
It is unknown that people keep ready cash which is neither used productively nor for purchasing consumer goods. Keynes mentioned three motives for holding ready cash for liquidity preference. This implies that the re-spent part of income goes on reducing. In this way, a part of the initial expenditure runs out of the income stream.
(c) Imports:
The part of the money spent by the country people for importing goods also runs out of the country’s income stream. As a result it does not encourage any business in the country especially if the imports do not help the trade and industry of the country or if they are not employed for export promotion. The net import is considered a leakage.
It generally happens that a person has to pay a debt to a bank or to another person. A portion of his income goes out in repaying such debts and is not employed either in consumption or in productive area. Income used to pay off debts runs out of the income stream. If the creditor spends this amount in purchasing consumer goods or in some productive activity this amount will generate some income otherwise not.
(b) Idle cash balances:
It is unknown that people keep ready cash which is neither used productively nor for purchasing consumer goods. Keynes mentioned three motives for holding ready cash for liquidity preference. This implies that the re-spent part of income goes on reducing. In this way, a part of the initial expenditure runs out of the income stream.
(c) Imports:
The part of the money spent by the country people for importing goods also runs out of the country’s income stream. As a result it does not encourage any business in the country especially if the imports do not help the trade and industry of the country or if they are not employed for export promotion. The net import is considered a leakage.
(d) Purchase of existing securities:
Some people purchase securities (saving certificates) from others and the seller of securities can hoard this money. This may also apply to purchase of shares, investment in debentures, purchase of bonds, insurance policy, or some other financial instrument. If this invested money is not employed in productive areas, there will be a leakage from the income stream.
Some people purchase securities (saving certificates) from others and the seller of securities can hoard this money. This may also apply to purchase of shares, investment in debentures, purchase of bonds, insurance policy, or some other financial instrument. If this invested money is not employed in productive areas, there will be a leakage from the income stream.
(e) Inflation:
Inflationary situation is also responsible for leakage from the income stream. In such a condition, investment does not assist in generating employment or enhancing income. If there is already a situation of full employment in the economy, increase in investment, far from enlarging demand for consumer goods decreases as a result of which employment in the consumer goods industries contracts and demand for capital goods decreases.
Inflationary situation is also responsible for leakage from the income stream. In such a condition, investment does not assist in generating employment or enhancing income. If there is already a situation of full employment in the economy, increase in investment, far from enlarging demand for consumer goods decreases as a result of which employment in the consumer goods industries contracts and demand for capital goods decreases.
As a result
of leakages of income from the main income stream of the country, the
multiplier effect of the primary investment in increasing income gets reduced. If in some manner these leakages are stopped,
the multiplier effect of investment in generating income and creating
employment would increase. If they
cannot be plugged at all, they should be reduced or the propensity to consume
should be increased or propensity to save should be brought down, otherwise the
fresh investment will not have complete effect in increasing income and
employment.
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