Question

For a hypothetical economy, the government incurs an additional investment expenditure of Rs.5,000 crore. Assuming that the Marginal Propensity to Save (MPS) becomes half from its present level of 20 percent, estimate the change in income due to this fall in MPS.

Hint:

A lower MPS leads to a higher investment multiplier, resulting in a greater increase in national income.

Answer 1

The change in income is calculated using the investment multiplier formula:\[\text{Multiplier} (K) = \frac{1}{\text{MPS}}\]Step 1: Initial Multiplier Calculation Initial MPS = 20% = 0.20 \[K_1 = \frac{1}{0.20} = 5\]Step 2: New Multiplier Calculation (MPS Reduced by Half) New MPS = 10% = 0.10 \[K_2 = \frac{1}{0.10} = 10\]Step 3: Change in Income Calculation Change in income (\(\Delta Y\)) resulting from an additional investment:\[\Delta Y_1 = K_1 \times \Delta I = 5 \times 5000 = 25000\]\[\Delta Y_2 = K_2 \times \Delta I = 10 \times 5000 = 50000\]Final Answer: The income increase resulting from the reduction in MPS is:\[{\Delta Y = 50000 - 25000 = Rs. 25,000 \text{ crore}}\]