Increase in income Rs. 2000 crore and MPC =0.8. How much increase in investment is there ?
Answer & explanation
Correct answer: option 2
The correct answer is option (2) : 400 crore
The increase in investment can be calculated using the formula for the investment multiplier. The investment multiplier is the reciprocal of the marginal propensity to save (MPS), and it shows the total increase in income for a given change in investment.
The formula for the investment multiplier is :
Investment multiplier = $\frac{\Delta Y}{\Delta I}$ = $\frac{1}{1-mpc} $
where MPC is the marginal propensity to consume.
Given that MPC (marginal propensity to consume ) is 0.8, the marginal propensity to save (MPS) is 0.2.
Investment multiplier = $\frac{1}{1- 0.8}$
= 5 times
Investment multiplier = $\frac{\Delta Y}{\Delta I}$
$\frac{\text{CHANGE IN INCOME}}{\text{CHANGE IN INVESTMENT}}=\text{K(INVESTMENT MULTIPLIER)}$
$\frac{2000}{x}=5$
$x=400$