The process of working of the investment multiplier is as under:
(i) It can be illustrated with the help of a simple example. We know that one man’s expenditure is another man’s income.
(2) Suppose, the government of a country spends Rs 100 crore on building roads. National income of the country automatically rises by Rs 100 crore in Round 1. Now suppose MPC is 0.5, people working in the investment industry will spend Rs 50 crore on new consumption goods.
(3) The consumer goods industry will have an extra income of Rs 50 crore. Assume the MPC for the whole society is 0.5, people working in these consumer goods industry would again spend 50% of their additional income of Rs 50 crore (which works out to be 25 crore) on more consumer goods.
(4) These Rs 25 crore will, thus, become the income for others. This will continue till total increase in income becomes k times the increment of investment.