Investment Multiplier Income Theory

Keynes’ General Theory provides an explanation of the determinants of the level of income and employment at any time. In Keynes’ analysis, the level of income and employment is determined by two factors:  (i) consumption, and (ii) investment. Of the two determinants of employment, consumption is relatively a stable phenomenon in the short run. In contrast, investment is a highly variable factor. By increasing or decreasing it, the government can ensure full employment or economic stability as the need may be.

Keynes emphasized that as employment increases, income also increase. A fundamental principle is that as income increase consumption also increases but less than income, therefore, there will be a gap between income and consumption demand out of that income. At every level of income, in order to maintain that level of income and employment, it is necessary that whatever is not spent on consumption expenditure must be invested by the recipients of income themselves or by the state. Since consumption expenditure increase by less than income when income increases, there can be no increase in employment unless there is an increase in investment. This means that investment must increase to fill the gap between income and expenditure.

Keynes’ theory of multiplier is an integral part of the theory of income and employment. He assigned an important role to multiplier in raising the level of output, employment and income in the economy. In Keynes’ analysis, investment multiplier means that when investment increases, national income and employment will also increase not only by the amount of investment but by some multiplier of it, and this will depend on the size of multiplier. The value of multiplier is related to the marginal propensity to consume and is equal to the reciprocal of marginal propensity to save. If the marginal propensity to save is low, the multiplier will be higher. On the other hand, if the marginal propensity to save is higher, the multiplier will be smaller. It shows that the size of multiplier has an inverse relationship to the marginal propensity to save and a direct relationship to the marginal propensity to consume.

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