Q.For a hypothetical economy, assume the government increased an infrastructural investment by ₹ 10,000 crore. 80% of additional income is consumed in the economy. Estimate the increase in income and the corresponding increase in consumption expenditure in the economy.

The increase in infrastructural investment triggers the investment multiplier effect, leading to a larger increase in the economy's income and consumption.

Given that 80% of additional income is consumed, the MPC is $0.8$.

The multiplier is calculated as:

$k = \frac{1}{1 - 0.8} = \frac{1}{0.2} = 5$

The increase in income ($\Delta Y$) is found by multiplying the initial investment by the multiplier:

$\Delta Y = k \times \Delta I$

$\Delta Y = 5 \times \text{₹ } 10,000 \text{ crore}$

$\Delta Y = \text{₹ } 50,000 \text{ crore}$ …

This question explores the concept of the investment multiplier and its impact on aggregate demand and national income. The core idea is that an initial injection of spending into the economy, such as government investment, doesn't just increase income by that initial amount. Instead, it sets off a chain reaction of spending and re-spending, leading to a much larger total increase in income. This is because one person's expenditure becomes another person's income, and a portion of that new income is then spent again, and so on.

The extent to which income increases depends on the Marginal Propensity to Consume (MPC), which is the proportion of additional income that households spend rather than save. A higher MPC means that a larger portion of each round of new income is re-spent, leading to a stronger multiplier effect. In an economy, equilibrium income is determined where aggregate demand equals aggregate supply. An increase in investment shifts the aggregate demand curve upwards, leading to a new, higher equilibrium level of income.

Let's calculate the increase in income and consumption expenditure:

1. Identify the given values:

   • Increase in infrastructural investment ($\Delta I$) = ₹ 10,000 crore
   • Marginal Propensity to Consume (MPC) = 80% = 0.8

2. Calculate the Investment Multiplier ($k$):

   The investment multiplier quantifies how much national income changes for a given change in investment. It is inversely related to the Marginal Propensity to Save (MPS), or directly related to the MPC.

   The investment multiplier ($k$) is given by:

   $k = \frac{1}{1 - \text{MPC}}$

   or

   $k = \frac{1}{\text{MPS}}$

   Substituting the given MPC:

This means that for every rupee of additional investment, the national income will increase by 5 rupees.

3. Estimate the increase in income ($\Delta Y$): …