Concept 1

MULTIPLIER ANALYSISI
Multiplier - INCREASE IN THE LEVEL OF
EQUILIBRIUM INCOME FOR A UNIT INCREASE IN
AUTONOMOUS SPENDING
For e.g. If Consumption function is given as
Y=a+by (where b is MPC) then
Y-by = a (where a is the autonomous consumption component)
Y (1-b) = a
Y = 1/1-b* a (where 1/1-b is the multiplier)
In case of we Include Govt. exp “a” can be represented as A
(autonomous Component) and we can write the above as Y=A/1-
bIIIII
Working of the multiplier-Concept 2
100cr
1st round
MPC 0.9
90cr

MPC 0.9
2nd round
81
3rd round
MPC 0.9

72.8 4th round

MPC 0.9
Total
1000cr increase in Y
A utonomous Component refers to
Variables not affected by income
Induced component is where it is
related to income in a certain proportion\

Consumption function
Eg If C= 45+0.8Y (a+by)
45 = autonomous component
And 0.8y is the induced component

Investment function (Concept 3)

Normally investment is taken as autonomous but
It can have an induced component also
I= c+dy where c is autonomous and dy is induced
Find the MPC and complete the table
Illustration of the working of the multiplier
Particulars Increase in Change in Change in Saving
Income Consumption (Rs. Crores)
(Rs. Crores) (Rs. Crores)

Fist Round 1000 800 200

Second Round 800
Third Round 640

All other Rounds  2,560

Total 5,000
Expenditure Multipliers without any
constraint on fiscal variables Variable Impact
Multipliers
Capital expenditure Multiplier 2.45
Transfer Payments Multiplier 0.98
Other Revenue Expenditure Multiplier* 0.99I
A multiplier ris a factor in economics that proportionally
augments or increases other related variables when it is
applied. Multipliers are commonly used in the field
of macroeconomics—the area of economics that studies the
behavior of the economy as a whole. There are a number of
different multipliers including the earnings multiplier, fiscal
multiplier, investment multiplier, and the Keynesian
multiplier. Read on to find out more about the Keynesian
multiplier and how it works.
CONCEPT 5
A Keynesian multiplier is a theory that
states the economy will flourish the more
the government spends.

According to the theory, the net effect is

greater than the dollar amount spent by the
government.

Critics of this theory state that it ignores

how governments finance spending by
taxation or through debt issues.
 Simple multiplier
(Concept 5)
SIMPLE ECONOMY –AUTONOMOUS (CONSUMPTION CONSIDERED)

(a) Y = AD
= 1C+S 1
(1  b)
= a+by 1

1
1  MPC MPS

y-by = a
y (1-b) = a )

y = (1/1-b) X a
TWO SECTOR MODEL

AUTONOMOUS INVESTMENT &CONSUMPTION CONSIDERED

*CONCEPT 6)

Y=C+I
Y= a+by +I
Y-BY = a+I
Y= 1/1-b X (a+I)

Investment multiplier)
k = Y
I
Illustration
MPC= 0.80
Increase in investment =40cr
Find change in eqb level of income
Change in consumption expenditure

1/1-b = 1/1-0.80=5

5x40=200
Therefore change in consumption
Expenditure = 200-40=160
Concept 6
Three sector model Economy with autonomous
Spending,Govt expenditure and Investment
Y = C+I+G
= (a+by) +I+ G
= (a+I+G)(11b)
Where (a+I+G) is autonomous component
Concept 7
Govt expenditure multiplier
k = Y
G
Illustration
Suppose Govt increases its exp by
20 cr and MPC is 0.8. What will be
the change in income.

1/1-b x 20cr
1/0.2x 20 =
5x20 =100
k=Y/  G , 100/20=5
Multiplier and Autonomous component - Shifts in Aggregate
demand

1/1-b x (C+I) - Simple Multiplier

1/1-b(1-t) x ( C+I+G)- Tax multiplier

1/1-b+m x (( C+I+G+X)- Foreign Trade multiplier

Relationship between income and consumption
growth
S=I (India)
 Chart Title

GE
12%

GDCF PFCE
33% 55%

NX- mostly negative%

SIMPLE ECONOMY WITH S&I (Concept1}
WAGES&PROFITS(Y)
Rs1000

Y=AD
Y=C+I
PRODUCTIVE S=I HOUSEHOLD
SECTOR SECTOR

PRIVATE
CONSUMPTION
Rs 800 ( C)
SAVING
INVESTMENT
Rs 200
Rs 200
Consumption and income(concept 2)
Disposable Spending
Consumption
Income
(PFCE)

MPC(Marginal propensity to consume) in

different countries

AD=
C I G NX
+ + +
(X-M)
 INVESTMENT FUNCTION
INVESTMENT DEMAND - DEMAND BY BUSINESS FOR OUTPUT WITH
WHICH TO MAINTAIN OR INCREASE THE TOTAL CAPITAL
STOCK

The investment function expressed mathematically as I = f(y)=n- I/r

r =rate of interest
N = Autonomous component

I/r is the marginal response of investment to rate of interest

The following fig. Indicates the relationship between investment. Interest rate and income.

I2
I0 I = f(y1)
I1
I = f(yo)
r0 r1
INCOME DETERMINATION MODEL (INCLUDING MONEY
AND INTEREST)
INTRODUCTION
IS-LM MODEL Studies the interaction of the goods & assets markets using
the IS-LM curves. Interest rate is considered in
determination of (AD)

Illustrates how monetary and Fiscal policies can prove

effective

Assumption of the earlier model are done away with. E.g.

Autonomous Investment concept.
Investment dependant on interest.

Interest rate
I- hr
I
 STRUCTURE OF THE IS –LM MODEL

INCOME

ASSETS MARKET GOODS MARKET

Money mkt Bond mkt AGGREGATE

Demand Demand DEMAND
Supply Supply OUTPUT

Interest rates

Monetary policy Fiscal policy

Money Supply and Banking? Operations using
these rates, Measures of money supply,
Process of credit creation

Policy Repo Rate: 4.00%

Reverse Repo Rate: 3.35%
Marginal Standing Facility Rate: 4.25%
Bank Rate: 4.25%

Base Rate: 7.40% - 8.80%MCLR (Overnight):

6.65% - 7.10%
Savings Deposit Rate: 2.70% - 3.00%Term
Deposit Rate > 1 Year: 4.90% - 5.50%
The Reserve Bank of India held its benchmark repo rate at 4 percent during its
October meeting, as widely expected. Policymakers said the decision is consistent
with neutral monetary policy stance and is in line with achieving the inflation target of
4 percent +/-2 percent while supporting economic growth and mitigate the impact of
COVID-19 on the economy. For 2020-21, policymakers expect inflation to average
6.8 percent for the second quarter of the year and a range of 5.4 - 4.5 percent for the
second half. GDP growth for 2020-21 is expected to contract 9.5 percent, with risk
tilted to the downside (-9.8 percent) in the second quarter of 2020. source: 
Reserve Bank of India
 Repo rate(Rate at which commercial banks borrow at
Short term from RBI.)

Commercial
LENDS Banks

RBI

Lending rate
Repo rate Borrowing PLR
of Banks

C&I
As the new MCLR is linked to Repo Rate, any decrease in repo rate will lead to increase in
MCLR.MCLR is a tenor-linked internal benchmark, which means the rate is determined
internally by the bank depending on the period left for the repayment of a loanThe RBI
introduced the MCLR methodology for fixing interest rates from 1 April 2016

.
• This will lead to decrease in interest rate for borrowers who have taken floating rate home
loan , personal loan and business loan

As the Repo Rate is decreased, the demand for due to higher credit facilities (loan) will increase,
interest rate
 GOODS MARKET

Aggregate demand = Aggregate Supply

AD = Total Output (Y)

Consumption function C = C(Y)

Investment function I = I ( r )
Equilibrium condition Y = C(Y)+ I ( r )

Y= C+I

Saving Investment Approach

I= S
Saving function S = S(Y)
Investment function I = I ( r )
Equilibrium condition S(Y) = I ( r )
IS Curve - Algebraic explanation

Aggregate Demand = Total Value of Outpur (Y)

Y= C+I

Where C= C +by
And I – hr

Y = C+ by – I +hr

Y-by = C+ I - hr

Y = 1/1-b (a+ I - hr) - IS equation for 2 sector model

Y = 1/1-b(/1-t)( (a+ I - hr +G) - IS equation for 3 sector model with G

&ty(tax rate)
 Derivation of the IS Curve(GOODS MARKET Where Agg demand =output)
First of all, we will have to modify the aggregate demand function of the earlier
chapter to reflect the new planned investment spending schedule. Here we see that only
I is redefined as I- hr AD
AD=Y
AD2
E2

AD1

E1

IS curve is
Y derived from
Y1 Y2
the AD curve
(same Y and r)
E1
r1 E2
IS curve shows r2
Combinations of Y and i IS
Where demand for
goods(AD)=
Its supply y1 y2
 Slope of IS curve

From the above equation it can be seen that the

steepness of the IS curve depends on the multiplier and
investment sensitiveness to change in interest rates (h)
Higher these values is then the IS curve would flat.

Policy will be more effective

 Shifts in IS curve
investment function at all interest rates changes the
Saving function and increases

Interest rate

I= I -hr

Planned investment spending

Any change in Government expenditure  G shifts income multiplier times

1/1-b  Y and IS curve shifts to the right
A reduction in taxes  Y/  T also shifts IS curve to right
MONEY MARKET (LM curve)

Money Supply = Money demand

Ms = ky-hr
Relationship between income and consumption
growth
S=I (India)
 Chart Title

GE
12%

GDCF PFCE
33% 55%

NX- mostly negative%

SIMPLE ECONOMY WITH S&I (Concept1}
WAGES&PROFITS(Y)
Rs1000

Y=AD
Y=C+I
PRODUCTIVE S=I HOUSEHOLD
SECTOR SECTOR

PRIVATE
CONSUMPTION
Rs 800 ( C)
SAVING
INVESTMENT
Rs 200
Rs 200
Consumption and income(concept 2)
Disposable Spending
Consumption
Income
(PFCE)

MPC(Marginal propensity to consume) in

different countries

AD=
C I G NX
+ + +
(X-M)
 INVESTMENT FUNCTION
INVESTMENT DEMAND - DEMAND BY BUSINESS FOR OUTPUT WITH
WHICH TO MAINTAIN OR INCREASE THE TOTAL CAPITAL
STOCK

The investment function expressed mathematically as I = f(y)=n- I/r

r =rate of interest
N = Autonomous component

I/r is the marginal response of investment to rate of interest

The following fig. Indicates the relationship between investment. Interest rate and income.

I2
I0 I = f(y1)
I1
I = f(yo)
r0 r1
INCOME DETERMINATION MODEL (INCLUDING MONEY
AND INTEREST)
INTRODUCTION
IS-LM MODEL Studies the interaction of the goods & assets markets using
the IS-LM curves. Interest rate is considered in
determination of (AD)

Illustrates how monetary and Fiscal policies can prove

effective

Assumption of the earlier model are done away with. E.g.

Autonomous Investment concept.
Investment dependant on interest.

Interest rate
I- hr
I
 STRUCTURE OF THE IS –LM MODEL

INCOME

ASSETS MARKET GOODS MARKET

Money mkt Bond mkt AGGREGATE

Demand Demand DEMAND
Supply Supply OUTPUT

Interest rates

Monetary policy Fiscal policy

Money Supply and Banking? Operations using
these rates, Measures of money supply,
Process of credit creation

Policy Repo Rate: 4.00%

Reverse Repo Rate: 3.35%
Marginal Standing Facility Rate: 4.25%
Bank Rate: 4.25%

Base Rate: 7.40% - 8.80%MCLR (Overnight):

6.65% - 7.10%
Savings Deposit Rate: 2.70% - 3.00%Term
Deposit Rate > 1 Year: 4.90% - 5.50%
The Reserve Bank of India held its benchmark repo rate at 4 percent during its
October meeting, as widely expected. Policymakers said the decision is consistent
with neutral monetary policy stance and is in line with achieving the inflation target of
4 percent +/-2 percent while supporting economic growth and mitigate the impact of
COVID-19 on the economy. For 2020-21, policymakers expect inflation to average
6.8 percent for the second quarter of the year and a range of 5.4 - 4.5 percent for the
second half. GDP growth for 2020-21 is expected to contract 9.5 percent, with risk
tilted to the downside (-9.8 percent) in the second quarter of 2020. source: 
Reserve Bank of India
 Repo rate(Rate at which commercial banks borrow at
Short term from RBI.)

Commercial
LENDS Banks

RBI

Lending rate
Repo rate Borrowing PLR
of Banks

C&I
As the new MCLR is linked to Repo Rate, any decrease in repo rate will lead to increase in
MCLR.MCLR is a tenor-linked internal benchmark, which means the rate is determined
internally by the bank depending on the period left for the repayment of a loanThe RBI
introduced the MCLR methodology for fixing interest rates from 1 April 2016

.
• This will lead to decrease in interest rate for borrowers who have taken floating rate home
loan , personal loan and business loan

As the Repo Rate is decreased, the demand for due to higher credit facilities (loan) will increase,
interest rate
 GOODS MARKET

Aggregate demand = Aggregate Supply

AD = Total Output (Y)

Consumption function C = C(Y)

Investment function I = I ( r )
Equilibrium condition Y = C(Y)+ I ( r )

Y= C+I

Saving Investment Approach

I= S
Saving function S = S(Y)
Investment function I = I ( r )
Equilibrium condition S(Y) = I ( r )
IS Curve - Algebraic explanation

Aggregate Demand = Total Value of Outpur (Y)

Y= C+I

Where C= C +by
And I – hr

Y = C+ by – I +hr

Y-by = C+ I - hr

Y = 1/1-b (a+ I - hr) - IS equation for 2 sector model

Y = 1/1-b(/1-t)( (a+ I - hr +G) - IS equation for 3 sector model with G

&ty(tax rate)
 Derivation of the IS Curve(GOODS MARKET Where Agg demand =output)
First of all, we will have to modify the aggregate demand function of the earlier
chapter to reflect the new planned investment spending schedule. Here we see that only
I is redefined as I- hr AD
AD=Y
AD2
E2

AD1

E1

IS curve is
Y derived from
Y1 Y2
the AD curve
(same Y and r)
E1
r1 E2
IS curve shows r2
Combinations of Y and i IS
Where demand for
goods(AD)=
Its supply y1 y2
 Slope of IS curve

From the above equation it can be seen that the

steepness of the IS curve depends on the multiplier and
investment sensitiveness to change in interest rates (h)
Higher these values is then the IS curve would flat.

Policy will be more effective

 Shifts in IS curve
investment function at all interest rates changes the
Saving function and increases

Interest rate

I= I -hr

Planned investment spending

Any change in Government expenditure  G shifts income multiplier times

1/1-b  Y and IS curve shifts to the right
A reduction in taxes  Y/  T also shifts IS curve to right
MONEY MARKET (LM curve)

Money Supply = Money demand

Ms = ky-hr