Which of the following is correct about investment multiplier ?

Question

Accepted Answer

The correct option is 4:

The investment multiplier, a core concept developed by economist John Maynard Keynes, describes the total increase in national income resulting from an initial increase in investment expenditure. It captures the cumulative effects of investment, where one person's spending becomes another person's income, leading to a chain reaction of spending and income generation throughout the economy. Mathematically, the multiplier (K) is defined as the ratio of the total change in income ($\Delta Y$) to the initial change in investment ($\Delta I$). The formula is: K = $\Delta Y$ / $\Delta I$. This relationship is crucial for understanding how government fiscal policy, particularly investment in public works, can stimulate the economy and generate income significantly larger than the initial outlay.

The incorrect option is 1: This option defines the ratio of change in consumption ($\Delta C$) to change in investment ($\Delta I$), which does not represent the investment multiplier. While consumption is a component of the multiplier process, the multiplier itself relates the total income change to the initial investment change.

The incorrect option is 2: This ratio ($\Delta S / \Delta I$) is not the definition of the investment multiplier. Furthermore, the ratio of the change in saving to the change in income ($\Delta S / \Delta Y$) is known as the Marginal Propensity to Save (MPS), which is instead inversely related to the multiplier (K = 1/MPS).

The incorrect option is 3: This option describes the ratio of change in consumption to change in saving ($\Delta C / \Delta S$), which is not a standard macroeconomic concept or the definition of the investment multiplier. The correct relationship between consumption and saving is expressed through the Marginal Propensity to Consume (MPC = $\Delta C / \Delta Y$) and the Marginal Propensity to Save (MPS = $\Delta S / \Delta Y$).