MARGINAL PROPENSITY TO IMPORT

The multiplier might ignore foreign economic effects that are important for countries with a large foreign trade sector. Consider a rise in UK investment partially spent on imports will increase the national income of another economy and might therefore lead to a further rise in UK exports. This would create further multiplier effects. 

A fall in aggregate demand: The multiplier effect works for decline in demand too. The cancellation of an export order or the loss of a planned investment project can have a negative multiplier effect on the regional or national economy. 
 

Supply-side capacity of the economy

It is assumed that an increase in aggregate demand leads to a rise in real national output when the economy has the spare capacity to meet the increase in demand, However, there are occasions when any further increase in demand will create an inflationary gap. 

A further assumption is that interest rates remain constant - it may well be the case that when aggregate demand is rising the central bank may take steps to curb the growth of demand by raising official interest rates. 

While Keynes propounded the concept of multiplier with reference to increase in investment and income. The multiplier is that total increase in income, output or employment results manifold the original increase in investment. 

The multiplier is, therefore, the ratio of increment in income to the increment in investment. If DI stand for increment in investment and DY for the resultant increase in income, the multiplier is equal to the ratio of increment in income (DY) to the increment in investment (DI) Therefore k = DY/ DI where k stands for multiplier. 
  
Keynes suggested the multiplier as a means to achieving full employment. This demand-management approach, aimed to help win a shortage of business capital investment. The higher the propensity to consume the greater is the multiplier effect. 

The size of the multiplier can be influenced by the government through changes in direct taxes. For example, a reduction in the basic rate of income tax will increase the amount of extra income that can be spent on further goods and services. 

Another factor affecting the size of the multiplier effect is the propensity to import. If, out of extra income, people spend money on imports, this demand is not passed on in the form of extra spending on domestically produced output.