Let
us understand the logic behind the direct relationship between MPC and
multiplier through Multiplier
Mechanism. It runs like this:
1)
Suppose AB industry limited spends Rs. 100 crore in setting up a new plant
i.e ∆I
= Rs. 100 crore.
This
will lead to creating more demand for goods and services required for the
setting up of this new plant. There will more demand for machinery, raw
materials, labour etc.
This
will generate income for all those people who are associated with the setting
up this plant and leading to more output and income.
As
a result national income in the first will increase by an amount equal to
amount of investment i.e ∆Y = Rs. 100 crore
2)
This ∆Y = Rs. 100 crore would be
split into ∆C and ∆S as a part of income is spent and a
part of it is saved.
3)
In round – 2, ∆C would be converted into ∆Y
as people who receive this new income (Rs. 100 crore) directly from the
building of the factory will spend some of it on consumer goods like food,
clothing, TV, cars, etc.
Here comes an
important point:
The
exact amount of additional consumption expenditure depend on the MPC(c).
Suppose
MPC is 0.8, then
MPC = ∆C / ∆Y (as discussed in consumption function)
∆C = MPC (∆Y)
∆C = 0.5(100)
= Rs. 50 crore
If MPC is 0.4, then
∆C = 0.4(100)
= Rs. 40 crore
