Leakages in multiplier, Macroeconomics

In real life, the operation of simple multiplier is affected by many leakages. Leakages in the multiplier arise out of the following reasons:

(1) Saving: If all the income is spent on consumption, then every increase in investment will raise the level of income. But, if a large proportion of the income is kept as saving, it will certainly have different effect on the intensity of multiplier.

(2) Debt Cancellation: If the people use a large proportion of their income in debt repayment, they will have smaller amount of income left for consumption. As a result, marginal propensity to consume falls and the value of multiplier also goes down.

(3) Imports: If the imports of a country exceed its exports a large portion of the national income will go to foreigners. Consequently, the multiplier effect of this expenditure is transmitted abroad. In such a situation, any increase in the investment will not increase the level of income in the economy.

(4) Price Inflation: When the economic reaches the full employment level or very close to it, every increase in investment will bring about a simultaneous increase in the price level. A large portion of incremental income will be spent in buying costly things; therefore, the intensity of multiplier becomes weak.

(5) Liquidity preference: People keep a part of their money income in liquid form. Liquidity preference reduces the present level of consumption of the community; as a result, the multiplier loses its strength. 

Posted Date: 7/8/2013 10:43:29 PM | Location : United States







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