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Investment Multiplier and Demand Concepts

Jul 21, 2024

Lecture Notes: Day 17 - Investment Multiplier and Demand Concepts

Introduction

  • Welcome: 17th day of the course, 4 days remaining.
  • Objective: Proudly say after efforts: Accomplished studying accounts, business studies, and economics.
  • Key Motive: Everything is achievable with effort.

Investment Multiplier

Definition and Concept

  • Meaning: Shows how much income is generated from investments.
  • Formula: k = ╬ФY / ╬ФI
    • Y: Income
    • I: Investment
  • Example: тВ╣4000 crores investment generating тВ╣20000 crores income gives a multiplier value of 5.

Process

  • Principle: One person's expenditure is another's income.
  • Rounds of Investment: Government invests тВ╣100 crores in smart city projects, income generation cycle explained with MPC (Marginal Propensity to Consume) at 0.9.
    • First Round: тВ╣100 crores investment тЖТ тВ╣100 crores income.
    • Subsequent rounds reduce as people spend part and save part of the income.
  • Final Calculation: When total savings equals the initial investment, the process stops.
    • Example: Multiplier value derived using the formula k = 1 / (1 - MPC).

Relationship with MPC and MPS

  • Direct Relationship: Between MPC and k.
  • Inverse Relationship: Between MPS (Marginal Propensity to Save) and k.

Excess Demand

Definition and Concept

  • Meaning: Demand exceeds the supply at full employment equilibrium.
  • Diagram: AD curve shows excess demand leading to inflationary gap.
  • Reasons for Excess Demand:
  1. Increased propensity to consume.
  2. Reduction in taxes.
  3. Increased government expenditure.
  4. Fall in imports.
  5. Rise in exports.
  6. Deficit financing.
  7. Increase in investments.

Inflationary Gap

  • Definition: Gap where actual AD exceeds the AD required for full employment equilibrium.
  • Causes: Rise in money supply, government expenditure, lower taxes.

Deficit Demand

Definition and Concept

  • Meaning: Demand is below the supply at full employment equilibrium.
  • Diagram: AD curve shows deficit demand leading to deflationary gap.
  • Reasons for Deficit Demand:
  1. Decrease in propensity to consume.
  2. Increase in taxes.
  3. Decrease in government expenditure.
  4. Rise in imports.
  5. Fall in exports.
  6. Decrease in investments.

Deflationary Gap

  • Definition: Gap where actual AD is below the AD required for full employment equilibrium.
  • Causes: Reduced money supply, lower government expenditure, higher taxes.

Controlling Excess and Deficit Demand

Fiscal and Monetary Policies

  • Fiscal Policy: Managed by the central government.

    • Components: Government expenditure and taxes.
    • **To control Excess Demand: Reduce government expenditure, increase taxes.
    • **To control Deficit Demand: Increase government expenditure, reduce taxes.

  • Monetary Policy: Managed by RBI.

    • Components: Quantitative (Repo Rate, Bank Rate, CRR, SLR) and Qualitative (Margin requirements, Moral suasion, Selective credit control).
    • Excess Demand: Increase Repo Rate, CRR, SLR; Sell government securities.
    • Deficit Demand: Decrease Repo Rate, CRR, SLR; Buy government securities.

Instruments in Detail

  • Quantitative Tools: Repo Rate, Bank Rate, CRR (Cash Reserve Ratio), SLR (Statutory Liquidity Ratio), and Open Market Operations.
  • Qualitative Tools: Margin requirements, moral suasion, selective credit control, and credit rationing.

Conclusion

  • Summary: Day 17 covered Investment Multiplier, Excess Demand, Deficit Demand, and fiscal and monetary policy measures to control them.
  • Next Steps: Upcoming lectures on government budget, BOP (Balance of Payments), and foreign exchange.
  • Closing Thought: Life is about the journey and not just the destination.

Full transcript