Investment Multiplier

Introduction Investment refers to the process or action of investing time, money, efforts and matter in something with the hope that it will generate income in future. The mechanism which shows how increase in investment leads to multiple increases in the income levels in the economy is called investment multiplier. It is denoted by K. The value of multiplier is determined by the marginal propensity to consume (MPC). Higher is the MPC, greater the size of multiplier. The multiplier formula can be derived by using the simple equilibrium condition for the two sector model. The Process of Multiplier is as follows: A change in investment leads to a change in income, which leads to a change in consumption. The various characteristics of Investment Multiplier are: It works in both directions forward and backward Multiplier is inversely related with Marginal Propensity to save (MPS) There is direct relationship between multiplier and Marginal Propensity to consume (MPC) Leakages affect the size of multiplier. Assumptions on which the theory of investment multiplier is based are No change in price, No induced investment Constant marginal propensity to consume, etc. Various kinds of leakages from multiplier process are taxes, savings, etc.

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  • Q1

    The relationship between investment demand and rate of interest is called

    Marks:1
    Answer:

    investment function.

    Explanation:
    The relationship between investment demand and rate of interest is called investment function. There is an inverse relationship between investment demand and rate of interest.
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  • Q2

    The value of multiplier depends on the

    Marks:1
    Answer:

    marginal propensity to cosume.

    Explanation:
    The value of multiplier depends on the value of marginal propensity to consume (MPC). MPC is the additional increase in consumption due to an increase in income.
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  • Q3

    An increase in interest rates on loan may result in

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    Answer:

    decrease in investment.

    Explanation:
    An increase in interest rates is likely to lead to a decrease in investment because demand for loan will decrease.
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  • Q4

    Investment demand function shows the functional relationship between investment demand and

    Marks:1
    Answer:

    rate of interest.

    Explanation:
    Investment demand function shows the functional relationship between investment demand and the rate of interest. There is an inverse relationship between rate of interest and investment demand.
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  • Q5

    Investment is an unstable element of aggregate demand because it depends heavily on

    Marks:1
    Answer:

    future expectations.

    Explanation:
    Investment is comparably unstable because it depends heavily on future expectations.It is erratic and may always be different at different times.
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