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.