'Investment multiplier and Marginal Propensity to Save are indirectly related to each other.' Explain with the help of numerical example.

Question

Accepted Answer

The investment multiplier and Marginal Propensity to Save (MPS) are inversely related. The multiplier formula in terms of MPS is k = 1/MPS, which shows that as MPS increases, the value of the multiplier decreases.

Numerical Example:
Consider two economies with different MPS values:

Economy A: MPS = 0.2
Multiplier (k) = 1/MPS = 1/0.2 = 5
If investment increases by ₹100 crores:
ΔY = k × ΔI = 5 × ₹100 = ₹500 crores

Economy B: MPS = 0.5
Multiplier (k) = 1/MPS = 1/0.5 = 2
If investment increases by ₹100 crores:
ΔY = k × ΔI = 2 × ₹100 = ₹200 crores

Explanation:
- Higher MPS means people save a larger proportion of additional income.
- This reduces the amount available for consumption in each round.
- Smaller consumption means smaller successive rounds of spending and income generation.
- The chain reaction of spending and income creation is weaker.
- Thus, the multiplier is lower when MPS is higher, confirming the inverse relationship.

The relationship can also be understood through MPC + MPS = 1. Since k = 1/(1-MPC) and 1-MPC = MPS, we get k = 1/MPS.