If the entire additional income of an economy is consumed, the value of investment multiplier will be _____ .

Question 22 of 104

Q. If the entire additional income of an economy is consumed, the value of investment multiplier will be _________ . (Choose the correct alternative) (A) zero

(0) (B) not defined (∞) (C) one

(1) (D) ten (10)

Kerala DhseCBSE Class XII Board 2020Subjective· 1mImportance★★★★★

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Concept understanding — Marginal Propensity to Consume

Marginal Propensity to Consume (MPC)

Start with everyday intuition

Think about what happens when you get some extra money — say, a ₹500 bonus from your part-time job, or a cash gift on your birthday. You don't save all of it, and you don't spend all of it either. Most people spend a part and save the rest. That part you spend — the fraction of the extra income that goes into consumption — is exactly what economists call the Marginal Propensity to Consume.

The word "marginal" here means "extra" or "additional." So MPC answers one simple question: Out of every extra rupee you earn, how much do you spend?

The precise meaning

Formally, MPC is the ratio of change in consumption expenditure to the change in income that brought it about.

MPC = \frac{\Delta C}{\Delta Y}

For example, if your income rises by ₹1,000 and your consumption rises by ₹750, your MPC is $750/1000 = 0.75$ (or 75%). This means you spend 75 paise of every extra rupee and save the remaining 25 paise.

The other side of the coin is the Marginal Propensity to Save (MPS) — the fraction of extra income that is saved. Since every extra rupee is either spent or saved:

MPC + MPS = 1

This is not a theory; it's an accounting identity. If MPC = 0.75, then MPS must be 0.25.

Why MPC matters

MPC is not just a number — it is the engine of the multiplier effect, one of the most powerful ideas in macroeconomics.

When someone spends money, that spending becomes someone else's income. That second person, in turn, spends a fraction (their MPC) of that income, which becomes a third person's income, and so on. A single initial injection of spending — say, government investment in a road — ripples through the economy, generating total income many times larger than the original spending.

The size of this ripple depends directly on MPC. The higher the MPC, the larger the multiplier.

Multiplier\ (k) = \frac{1}{1 - MPC} = \frac{1}{MPS}

If MPC = 0.8, the multiplier is $1/(1-0.8) = 5$ . An initial ₹100 crore investment can generate ₹500 crore of total income. If MPC = 0.5, the multiplier is only 2.

A word on the diagram …

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When the entire additional income is consumed, the marginal propensity to consume (MPC) is $1$ , so the investment multiplier $k = \frac{1}{1 - \text{MPC}} = \frac{1}{0}$ is not defined (infinite). The correct alternative is (B) not defined (∞).

The Concept: Why the Multiplier Depends on Consumption

The investment multiplier ( $k$ ) measures how many times an initial increase in investment ( $\Delta I$ ) boosts the final income ( $\Delta Y$ ). The logic is simple: one person’s spending becomes another’s income, which is then partly spent again, creating a chain. The strength of this chain depends on the marginal propensity to consume (MPC) — the fraction of each extra rupee of income that people spend on consumption.

If people spend all of their extra income (MPC = 1), then every rupee of new investment gets fully re-spent, over and over, with no leakage into savings. In theory, this would cause income to grow without bound — the multiplier becomes infinite. But is that the same as “not defined”? Let’s see.

Step-by-Step Reasoning

Recall the multiplier formula. The investment multiplier is derived from the equilibrium condition in a simple Keynesian model:

Y = C + I

where $C = \bar{C} + \text{MPC} \cdot Y$ . Solving gives:

k = \frac{\Delta Y}{\Delta I} = \frac{1}{1 - \text{MPC}}

Plug in the given condition. “The entire additional income is consumed” means MPC = 1 (since every extra rupee of income leads to an equal increase in consumption). Substituting:

k = \frac{1}{1 - 1} = \frac{1}{0}

Interpret the result. …

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Same / Similar Concept — real previous-year questions on the same or a closely similar concept, not this exact question.

CA Foundation 2025Set may-20251 markMCQ
$Q. Under the Keynesian theory of determination of national income, the assumption is that the consumption increases with an increase in disposable income but the increase in consumption will be _______ the increase in disposable income. (A) Equal to (B) Opposite to (C) Greater than (D) Less than$
›Reveal solutionSolution

By Keynes's fundamental psychological law, a rise in income raises consumption by less than the rise in income.

Step 1 — Keynes's psychological law of consumption

Keynes held that as disposable income increases, consumption increases too, but not by the full amount of the increase — people save a part of the additional income.

Step 2 — Express with MPC

The marginal propensity to consume measures the share of extra income that is consumed:
$MPC = \frac{\Delta C}{\Delta Y}, \qquad 0 < MPC < 1$
Since $MPC < 1$ , the change in consumption $\Delta C$ is less than the change in disposable income $\Delta Y$ . …
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CA Foundation 2025Set may-20251 markMCQ
$Q. Which of the following is true in respect of relation of Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) as per the Keynesian theory of determination of National Income ? (A) MPC = MPS (B) MPC + MPS = 1 (C) MPC + MPS = 0 (D) No relation exists between MPC and MPS$
›Reveal solutionSolution

Because extra income is either spent or saved, MPC + MPS = 1.

Step 1 — Split additional income

A change in disposable income ( $\Delta Y$ ) is divided between a change in consumption ( $\Delta C$ ) and a change in saving ( $\Delta S$ ):
$\Delta Y = \Delta C + \Delta S$
Step 2 — Divide through by $\Delta Y$
$\frac{\Delta C}{\Delta Y} + \frac{\Delta S}{\Delta Y} = 1 \;\Rightarrow\; MPC + MPS = 1$
So the two marginal propensities always sum to one, and MPS = 1 − MPC.

Why the other options are wrong: (A) MPC = MPS only in the special case where each equals 0.5; it is not a general rule. (C) MPC + MPS = 0 is impossible, since both are non-negative and their sum is 1. (D) A definite relation clearly exists, so 'no relation' is wrong. …
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Q.If the entire additional income of an economy is consumed, the value of investment multiplier will be _________ . (Choose the correct alternative) (A) zero

The Concept: Why the Multiplier Depends on Consumption

Step-by-Step Reasoning

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