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Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier : Karnataka university was recognized with the “Potential for Excellence” by the University Grants Commission. The university is the second oldest university in the state of Karnataka after the University of Mysore. The Karnatak university once used to serve most of the Karnataka region including Dharwad, Belagavi, Uttara Kannada, Bijapur, Gulbarga, Raichur, Bidar and Bellary. until the 1980s (Manipal Institute of Technology and the Kasturba Medical College of Manipal were affiliated with Karnatak University at Dharwad and all degrees were awarded by Karnatak University in between the years from 1953 to 1965)

Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier : We provides here Karnataka Class 12 Commerce Economics Multiplier  Complete details in PDF Format and here we gave direct download links for Karnataka Class 12 Commerce Economics Multiplier  pdf format. Download Karnataka Class 12 Commerce Economics Multiplier  Complete Notes here and read well.

Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier : Economics is a social science concerned with the production, distribution and consumption of goods and services. It studies how individuals, businesses, governments and nations make choices on allocating resources to satisfy their wants and needs, and tries to determine how these groups should organize and coordinate efforts to achieve maximum output.

Download here  Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier : In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable. For example, suppose variable x changes by 1 unit, which causes another variable y to change by M units. Then the multiplier is M. Multipliers can be calculated to analyze the effects of fiscal policy, or other exogenous changes in spending, on aggregate output. For example, if an increase in German government spending by €100, with no change in tax rates, causes German GDP to increase by €150, then the spending multiplier is 1.5. Other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes (such as lump-sum taxes or proportional taxes).

What is a ‘Multiplier’

In economics, a multiplier is the factor by which gains in total output are greater than the change in spending that caused it. It is usually used in reference to the relationship between investment and total national income. The multiplier theory and its equations were created by British economist John Maynard Keynes.

BREAKING DOWN ‘Multiplier’

By “investment,” Keynes meant government spending. He believed that any injection of government spending created a proportional increase in overall income for the population, since the extra spending would carry through the economy.

The Mathematics of the Multiplier

In his 1936 book “The General Theory of Employment, Interest, and Money,” Keynes wrote following equation to describe the relationship between income (Y), consumption (C) and investment (I): Y = C + I. For any level of income, people spend a fraction and save/invest the remainder.

Keynes represented the marginal propensity to save (MPS) as 1-b, and the marginal propensity to consume (MPC) as b. This creates the equations C = bY, and I = Y – C. In other words, bY determines how much remains for investments. Keynes rearranged the equations to solve for income, or Y = I / (1-b).

Here, Keynes re-defined Y as k, writing k = 1 / (1-b). This allowed Keynes to assert Y = k*I. Since investment was multiplied by k, Keynes referred to k as the multiplier. For any new injection of government spending, k showed the relationship between change in income (dY) and change in investment (dI), or dY = k*dI.

Given an MPC = 0.8, for example, then k = 1 / (1 – 0.8) = 5. This suggested any change in income will be five times the change in new investment, or new government expenditures.

Problems in Multiplier Maths

In Keynes’ first derivation, income (Y) is treated as an independent variable, or a cause which drives other changes in the economy; after introducing the concept of k, but investment (I) and the multiplier (k) were suddenly independent variables. Income became a dependent variable, or an effect.

Keynes’ multiplier reversed cause and effect after k was introduced. While still mathematically true, this reversal only demonstrated a necessary accounting relationship in Keynes’ equation, not any meaningful causal relationship.

For an analogy, consider the equation for converting Celsius into Fahrenheit: F = 32 + 1.8C. Here, an increase in 10 degrees Celsius implies an increase of 18 degrees Fahrenheit. This can be expressed mathematically as dF/dC = k, where k is a Celsius multiplier. (Mathematically, this is identical to the Keynesian multiplier.)

It would not make much sense to claim a 10-degree rise in Celsius causes an 18-degree rise in Fahrenheit. The two may be mathematically related in a fixed equation, but there is no sensible causal link involved. The same goes for Keynesian multipliers.

In fact, a derivation of the Keynesian multiplier can be written dY / dC = 1/b. With an MPC = 0.8, a change in income is only 1.25 times the change in new expenditures, not five times.

The multiplier effect in an open economy

As well as calculating the multiplier in terms of how extra income gets spent, we can also measure the multiplier in terms of how much of the extra income goes in savings, and other withdrawals. A full ‘open’ economy has all sectors, and therefore, three withdrawals – savings, taxation and imports.

This is indicated by the marginal propensity to save (mps) plus the extra income going to the government – the marginal tax rate (mtr) plus the amount going abroad – the marginal propensity to import (mpm).

By adding up all the withdrawals we get the marginal propensity to withdraw (mpw). The multiplier can now be calculated by the following general equation:


Applying the ‘multiplier effect’

The multiplier concept can be used any situation where there is a new injection into an economy. Examples of such situations include:

  1. When the government funds building of a new motorway
  2. When there is an increase in exports abroad
  3. When there is a reduction in interest rates or tax rates, or when the exchange rate falls.

Karnataka Class 12 Commerce Economics Multiplier Complete Notes

Karnataka Class 12 Commerce Economics Multiplier : Every time there is an injection of new demand into the circular flow there is likely to be a multiplier effect. This is because an injection of extra income leads to more spending, which creates more income, and so on. The multiplier effect refers to the increase in final income arising from any new injection of spending.

The size of the multiplier depends upon household’s marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps). It is important to remember that when income is spent, this spending becomes someone else’s income, and so on. Marginal propensities show the proportion of extra income allocated to particular activities, such as investment spending by UK firms, saving by households, and spending on imports from abroad. For example, if 80% of all new income in a given period of time is spent on UK products, the marginal propensity to consume would be 80/100, which is 0.8.

The Concept of Multiplier:

The theory of multiplier occupies an important place in the modern theory of income and employment. The concept of multiplier was first of all developed by F.A. Kahn in the early 1930s. But Keynes later further refined it. F.A. Kahn developed the concept of multiplier with reference to the increase in employment, direct as well as indirect, as a result of initial increase in investment and employment.

Keynes, however, propounded the concept of multiplier with reference to the increase in total income, direct as well as indirect, as a result of original increase in investment and income. Therefore, whereas Kahn’s multiplier is known as ’em­ployment multiplier’, Keynes’s multiplier is known as investment or income multiplier.

The essence of multiplier is that total increase in income, output or employment is manifold the original increase in investment. For example, if investment equal to Rs. 100 crores is made, then the income will not rise by Rs. 100 crores only but a multiple of it.

If as a result of the investment of Rs. 100 crores, the national income increases by Rs. 300 crores, multiplier is equal to 3. If as a result of investment of Rs. 100 crores, total national income increases by Rs. 400 crores, multiplier is 4. The multiplier is, therefore, the ratio of increment in income to the increment in investment. If ΔI stands for increment in investment and AY stands for the resultant increase in income, then multiplier is equal to the ratio of increment in income (Δy) to the increment in investment (ΔI). Therefore k = ΔY/ΔI where k stands for multiplier.

Now, the question is why the increase in income is many times more than the initial increase in investment. It is easy to explain this. Suppose Government undertakes investment expenditure equal to Rs. 100 crores on some public works, say the construction of rural roads.

For this Gov­ernment will pay wages to the labourers engaged, prices for the materials to the suppliers and remunerations to other factors who make contribution to the work of road-building. The total cost will amount to Rs. 100 crores. This will increase incomes of the people equal to Rs. 100 crores.

But this is not all. The people who receive Rs. 100 crores will spend a good part of them on consumer goods. Suppose marginal propensity to consume of the people is 4/5 or 80%. Then out of Rs. 100 crores they will spend Rs. 80 crores on consumer goods, which would increase incomes of those people who supply consumer goods equal to Rs. 80 crores. But those who receive these Rs. 80 crores will also in turn spend these incomes, depending upon their marginal propensity to consume. If their marginal propensity to consume is also 4/5, then they will spend Rs. 64 crores on consumer goods.

Thus, this will further increase incomes of some other people equal to Rs. 64 crores. In this way, the chain of consumption expenditure would continue and the income of the people will go on increasing. But every additional increase in income will be progressively less since a part of the income received will be saved. Thus, we see that the income will not increase by only Rs. 100 crores, which was initially invested in the construction of roads, but by many time more.

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