Answer to Question #31228 in Macroeconomics for meera pothunnah
explain the role of the multiplier in an economy?
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.