Income Determination Test - 21

Saving function is given in the form of: 
$$S = -\bar{C}+sY$$
where,

Propensity to consume refers to the proportion of income used as consumption expenditure. The fall in the propensity to consume is not responsible for creating excess demand in an economy.

Excess demand is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. It does not cause any change in the level of employment or output. As a result, inflation occurs in the economy.

The equilibrium is reached only when Investment(I) equals Savings(S) because at this level there is no tendency for income and output to change. 
In the diagram the equilibrium is at E1  where savings intersects investment curve At this point, I=S.
When S is more than I , then the planned inventory would fall below the desired level. To bring back the Inventory at the desired level, the producers expand the output More output means more income. Rise in output means rise in I and rise in income means rise in S. Both continue to rise till they reach E1, S=I. 
When S is less than I, then the planned inventory rises above the desired level. To clear the unwanted increase in inventory, firms plan to reduce the output till S becomes equal to I.
So, equilibrium takes place only at point E1, when S=I.

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment and it is denoted as 'k'.

Multiplier(k) => Change in income / change in investment = 1/ MPS(s) where s is the marginal propensity to save. 

So if MPS=MPC then ,

We know that MPC + MPS =1 

=> 2 MPS= 1 

=> MPS= 1/2 

=> MPS= 0.5  

Multiplier (K) = 1/ MPS= 2 times.

Hence, the value of the multiplier is two. 

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment and it is denoted as 'k'.

Multiplier(k) => Change in income / change in investment = 1/ {1-MPC(c)} where c is the marginal propensity to consume. 

If MPC= 0.6, then 

Multiplier(k) = 1/( 1 - 0.6) = 1/ 0.4 = 10/4 = 2.5 times.

Therefore, the investment multiplier is 2.5. 

When planned savings  is less than the planned investment , then the planned inventory rises above the desired level which denotes that the consumption is the economy was less then the expected level which indicates at less aggregate demand in comparison to aggregate supply. 

When economy decides to save the whole of its additional income, then MPS = 1. So 

Investment multiplier refers to the number of time by which the increase in output or income exceeds the increase in investment. It is measured as the ratio between change in income and change in investment and it is denoted as 'k'.

Multiplier(k) => Change in income / change in investment = 1/ {1-MPC(c)} where c is the marginal propensity to consume. 

Therefore, the value of multiplier will be maximum when the value of MPC is either infinity or zero. 

If the value of MPC IS greater than MPS, then the value of the multiplier is always more than two because the change in savings or investment will always be less than half the change in income.