How is Investment and National Income linked?
We know that
Investment is an Expenditure
This expenditure of one person is income of other person and the process continues
hence, Investment and Income are linked
Example 1
Suppose there are only 2 persons in economy- F (Firm) and Household (H)
Suppose Firm Increases its Investment Expenditure by 10000
It will do so by paying salary /rent etc to H of Rs 10000
This 10000 will become Income of H
Hence, Increase in Investment of F lead to increase in Income of Household
Example 2
A incurred Investment Expenditure of Rs 10000 by paying wages to B
This Rs 10000 is now income of B
Suppose Marginal Propensity to consume is 80%
It means B will spend 8000 out of this 10000 by paying to C
Hence, this 80000 becomes income of C
Suppose C spends 6400 out of this 8000 by paying to D
Hence, this 6400 becomes income of D and this process continues as under
In this case,
Investment Made by A =10000
Income earned by B,C,D etc=10000+8000+6400+..=50000
Hence, Increase in Investment leads to Increase in National Income by many times
This concept is called Investment Multiplier
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What is Investment Multiplier?
It is the ratio of Increase in National Income(Y) due to Increase in Investment (I)
It is denoted by k
Investment Multiplier=Increase In Income / Increase in Investment
K = Delta Y / Delta I
Example 1
Suppose on investment of 50000 ,Income earned is 10000
If investment increased to 60000,Income becomes 30000
In this case
Increase in Income =30000-10000=20000
Delta Y=20000
Increase in Investment =60000-50000=10000
Delta I=10000
Investment Multiplier=Increase In Income / Increase in Investment
K = Delta Y / Delta I
K = 20000 / 10000
K = 2
Example 2
An additional Investment of 20000 Crore in economy generate additional income of 30000 Cr
What is Value of Investment Multiplier?
Investment Multiplier=Increase In Income / Increase in Investment
K = Delta Y / Delta I
K = 30000 / 20000
K = 1.5
