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CA Foundation · Business Economics · Determination of National Income

Which of the following will make the investment multiplier in an economy smaller?

A rise in the marginal propensity to import makes the investment multiplier smaller. Imports are a leakage from the domestic income flow, so a larger share of each extra rupee of income goes abroad, reducing successive rounds of domestic spending. Lower saving, higher MPC or lower tax rates all raise the multiplier.

  1. AA fall in the marginal propensity to save
  2. BA rise in the marginal propensity to importCorrect
  3. CA rise in the marginal propensity to consume
  4. DA fall in the proportional income tax rate

Explanation

The multiplier is 1/(1 - MPC(1 - t) + MPM), so any rise in leakages (saving, taxes, imports) lowers it. A higher marginal propensity to import increases leakage and reduces the multiplier. The other options reduce leakages or raise induced spending, which increases the multiplier.

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