Elaborate using a hypothetical numerical example, how a given initial increase in investment affects the level of final income of the economy.
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The multiplier effect demonstrates that an initial increase in investment can have a larger impact on the economy. The greater the MPC, the larger the multiplier and, consequently, the greater the final increase in income.
Given a Marginal Propensity to Consume (MPC) of 0.75 and an initial investment increase of ₹ 200 crore. The multiplier effect is calculated using the formula: \[ \text{Multiplier} = \frac{1}{1 - MPC} \] Substituting the MPC: \[ \text{Multiplier} = \frac{1}{1 - 0.75} = 4 \] The final increase in income (ΔY) is determined by: \[ \Delta Y = \text{Multiplier} \times \text{Initial Investment} = 4 \times 200 = ₹ 800 \text{ crore} \] Consequently, the economy experiences a total income increase of ₹ 800 crore. This demonstrates the amplified impact of an initial ₹ 200 crore investment on overall economic income through the multiplier effect.