Investment Multiplier

Investment multiplier or output multiplier refers to the number by which change in investment (∆I) multiplies to become change in output/income (∆Y).It is measured as the ratio between change in output/income and change in investment.

K =  ∆Y / ∆I

K = Multiplier

∆Y = Increase in output/income

∆I = Increase in investment

Determination of Equilibrium Income and output

Saving And Investment Approach for determination of equilibrium income and Output

An alternative approach to the determination of equilibrium level of income is Saving Investment approach.According to this approach, equilibrium is struck at that level where planned investment equals planned saving.

i.e S = I

Since S refers to ‘withdrawal’ from the circular flow and I refers to ‘injection’ into the circular flow, equilibrium condition can be stated as:

Withdrawal = injection

Determination of Equilibrium Income and output

After discussing about consumption and investment function in my previous posts, we are now in a position to study and analyse the equilibrium level of income and output.

Basic Assumptions:

1) Short Period analysis – Keynesian theory of equilibrium output is determined only with reference to short period of time.Short run is defined as a period of time during which level of output is determined exclusively by the level of employement in the economy. Technology is assumed to remain constant.

2) Closed economy – Keyenes discuss the theory of equilibrium GDP in the context of a closed economy.This is an economy which has no relations with  the rest of the world,there is no import or export.

Its two sector economy consisting of the household sector and business sector.All the decisions concering consumption expenditure is taken by the individiula household, while the business firms take decisions regarding investment.

Induced and Autonomous Investment

Investment is an important determinant of the Aggregate demand and thereby of the level of income, output and employement.Investment is taken in the sense of real investment.

Investment refers to that part of the aggregate output which takes the form of new plants, new capital equipments and machinery, new structures (factories, office building, residential houses etc.) and addition to business inventories (stock of goods).

Private and Public Investment

Private Investment:

It refers to expenditure by private investors on the purchase of such goods which add to their stock of capital.

Investment implies increase in the stock of capital, also called Capital Formation.

Rate of interest is the principal determinants of private investment.

Higher rate of interest generally implies lower investment expenditure.

Investment in private sector is motivated solely by profit motive.

Public Investment:

Investment undertaken by the government is known as public investment.

The government often invest in projects like road, dams, schools, colleges, housing etc.

Public investment is largely motivated by public welfare.

Saving Function (2)

As we have already understood various components of savings, now here we will understand the saving function graphically. 

Tabular explanation of Consumption function

Y(Rs)	C (Rs)	S ( Y- C)
0 20 40 60 80 100 120	30 35 40 45 50 55 60	-30 -15 0 15 30 45 60

The above table shows:

Like consumption, saving is an increasing function of the level of income, i.e. the amount of saving increases with an increase in the level of income.