LIMITATIONS OF MULTIPLIER

Marginal propensity to consume (MPC) is considered the sole determinant of the investment multiplier. If MPC is 0.9 the value of multiplier would be 10. Hence, the initial investment can be multiplied ten times in terms of income for any economy. In practice, this may not materialize due to a number of leakages and limitations, which weaken the operation of the multiplier. Therefore, the magnitude of the actual multiplier, may be lower than the ideal one. That is why, inspite of great importance of the concept of multiplier it is not free from limitations.

1. Leakages from Income Stream

We generally observe that as the income increases, the marginal propensity to consume falls. As a result, the total increase in the income that we expect to take place on the basis of the constant MPC does not materlise. If the people retain a part of the income received as idle cash balances for various motives or for the repayment of their debts an other obligations such as personal taxes, the present level of the consumption of the community will fall. Further, MPC is very seldom equal to one. The whole increment in income is not spent on consumption. A part of it is saved which peters out of the income stream and so increase in income in the next round declines. Higher is the size of MPS, smaller will be the value of multiplier due to greater amount of leakage from theincome stream. The various leakages from the income reduce the value of MPC and hence thevalue of the multiplier. For the effective working of the multiplier, the income received should be spent so that it may come back again as income.

2. Purchase of Old Stocks and Shares

If a part of the increased income is used to buy old stocks and shares instead of consumer goods, the consumption expenditure will fall. In such a situation, its cumulative effect on income will be less than before.

3. Price Rise

When investment increases, the multiplier effect of increased income may be dissipated inituation of rising prices. Consequently, real consumption and income will fall. Rising prices may be the result of commodity taxation.

4. Availability of Consumer Goods   

The multiplier process leads to the income propagation through the expenditure on consumption goods. This requires the availability of the consumer goods in adequate quantities. If there is a shortage of these goods, the additional income received by the people may not be fully spent. In such a situation, the consumption plans of the people will remain unmateralised. The producers must raise the supply of the consumer goods to prevent the causes weakening the value of the multiplier. However, the producers, generally do not increase the production capacity until they are convinced that the increase in the demand for the consumer goods is stable.

5 . Imports

 When the imports of the country are more than the exports, a large part of the country’s income will go to the foreigners. The payment of  the imports is not available for the expansion of the internal production. The multiplier effect of this expenditure will be transmitted abroad. To that extent, an increase in the investment will not increase the level of income in the country.

6. Full Employment Ceiling

 When an economy approaches the full employment level, any new investment cannot increase the supply of the consumer goods or the factor services. The increased investment will have only the effect of diverting the employed resources from the other sectors or industries. Once the full employment level has been reached, income, output and employment levels will stop expanding, what so ever the value of  MPC might be. It will only result in higher price, i.e., inflation.