Answer to Question #31228 in Macroeconomics for meera pothunnah

Question

explain the role of the multiplier in an economy?

Answer 1

The concept of multiplier is of great significance in the economic analysis and policy.

1. Saving Investment Equality. The multiplier theory highlights the importance
of investment in theory of income and employment. As the consumption function
is stable during the short run, fluctuations in income and employment are
result of the fluctuations in the level of investment. A rise in investment
causes a cumulative rise in income and employment through the multiplier
process and vice versa. The multiplier theory not only explains the process of
income propagation as a result of rise in the level of investment, it also
helps in bringing equality between saving and investment. In case of divergence
between the two, change in the level of investment leading to a change in the
level of income via the multiplier process, ultimately equalizes saving and
investment.

2. Business Cycles. The multiplier process explains and helps in controlling
different phases of business cycles occurring due to fluctuations in the level of
income and employment. The boom period (high level of income and employment)
can be controlled by a reduction in investment, which leads to a cumulative
decline in income and employment in the multiplier process. On the other hand,
during the depression phase of business cycle (low level of income and
employment), an increase in investment leads to revival. If this process
continues, boom may be the result.

3. Formulation of Economic Policies. The government can decide upon the amount
of investment to be injected into the economy to reduce unemployment. The
multiplier theory helps the government in formulating an appropriate employment
policy during depression. During depression, Government’s public works
programs are more effective than cheap money policy due to multiplier effect
of investment. It is important to note that any increase in the investment in
one sector should not be accompanied by a decrease in the investment in the
other sector. An inter-sectoral transfer of the investment will not raise the
value of the multiplier. Further, it is necessary to ensure a steady injection
of the investment. That is, the increments in the investment should be repeated
at regular intervals so as to raise the level of the income and the employment
to the full employment level. Further, modifications in the Keynes theory of
the Multiplier will enhance the utility of the multiplier concept.