When, at a particular price level, aggregate demand for final goods equals aggregate supply of final goods, the final goods or product market reaches its equilibrium. Aggregate demand for final goods consists of ex ante consumption, ex ante investment, Government spending etc. The rate of increase in ex ante consumption due to a unit increment in income is called marginal propensity to consume. For simplicity we assume a constant final goods price and constant rate of interest over short run to determine the level of aggregate demand for final goods in the economy. We also assume that the aggregate supply is perfectly elastic at this price. Under such circumstances, aggregate output is determined solely by the level of aggregate demand. This is known as effective demand principle. An increase (decrease) in autonomous spending causes aggregate output of final goods to increase (decrease) by a larger amount through the multiplier process.
The value of investment multiplier in an economy is determined by :
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Inverse of marginal propensity to save
The investment multiplier is the ratio of the total rise in output to the first rise in autonomous spending. Its value is 1/(1 − c), where c is the marginal propensity to consume (MPC). Since 1 − c is the marginal propensity to save (MPS), the multiplier is 1/MPS.
The smaller the MPS, the more of each extra rupee is spent again, so the multiplier is larger. It depends on the share of extra income saved. Banking rules, gold reserves or the savings people already hold do not decide it.
Note: The passage of this question group is taken from the chapter ‘Determination of Income and Employment’ of the NCERT book. The short summary at the end of a chapter can turn up as a full passage, so read it slowly too.
NCERT (2026-27): Introductory Macroeconomics — Chapter 4: Determination of Income and Employment
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