MONEY MULTIPLIER

 F.A. Kahn, first of all, developed the concept of multiplier in the early 1930s. But Keynes later further refined it. Kahn developed the concept of multiplier with reference to the increase in employment as a result of initial increase in investment and employment.   When government undertakes public works such as roads, railways, construction of canals, hydroelectric stations, irrigation works the level employment increases. 

 This is primary employment.  These people then spend their income on consumer goods.  Consequently, demand for consumption goods increases which leads to increase in the output of concerned industries that provides further employment to additional people.  However, the process does not stop here.  The entrepreneurs and workers in these industries, where investment has been made, also spend their newly earned income that results in increasing output and opportunities for employment.  Thus, we find that the total employment so generated is several times more than the primary employment.
Keynes’ income multiplier puts forward that a given increase in investment ultimately creates total income that is many times the initial increases in income resulting from that investment.  For this reason, it is called income multiplier or investment multiplier.  Income multiplier shows how many times the total income increases by a given initial investment. Suppose $ 100 million is invested in public works and as a result there is an increase of $ 300 million in income. The income has increased 3 times Therefore, the multiplier is 3.  If ΔI indicates an increase in investment, ΔY represents+ increase in income and K is the multiplier. The multiplier can be expressed as K= ∆Y/ ∆I. The multiplier is the numerical co-efficient showing how large an increase in income will result from each increase in investment.  The multiplier is the times by which the change in investment must be multiplied in order to get the consequent change in income.  Thus, the multiplier is the ratio of change in income to the change in investment.  If an investment of $ 50 million increases income by $150 million the income multiplier is 3 and if $200 million, the multiplier is 4 and so on. In the multiplier equation, the association between income and investment is determined through marginal propensity to consume: K = 1/1-mpc, Where: 1 mpc = mps (mps: Marginal Propensity to Save). Therefore, the third multiplier equation is: K= 1/mps. It should be noted that the size of multiplier varies directly with the size of marginal propensity to consume.  When the mpc is high, the multiplier is also likely to be high and when the mpc is low, the multiplier also tends to be low.

Importance of Multiplier:

 Keynes’ principle of multiplier had a great role in removing the Great Depression of 1929-34.  These days governments actively interfere in the economic affairs of the community through multiplier. The importance of multiplier is further explained:

1. The concept of multiplier focuses on the importance of public investment, a key to remove unemployment during the depression.  An investment of $ 1 million can create income and employment worth several times, and can assist the government to remove unemployment from the country.

2. During the time of depression, the private entrepreneurs are de-motivated to invest in the economy.  Therefore, in order to fill this gap, the government comes forward and undertakes the investment in its own hands.  Hence, the demand for consumer goods increases and also the level of national income and employment increases on account of the working of the multiplier.

3. When the demand for goods increases and incomes rise owing to government investment, the entrepreneurs expect the profit to go up and as a result the marginal efficiency of capital rises.

4.   When the government makes investment in public works to fight depression and unemployment, private investment is encouraged on account of the operation of the multiplier.  The confidence of private investors is ensured, and hence helps in further removing the economic depression of the country.