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Drop ₹100 into the economy and watch it become ₹500

Choose how much of each extra rupee people spend, add some new investment, and watch the money ripple outwards. Then find equilibrium income, the money multiplier and the budget deficits, with every step written out.

The ripple

Try an MPC:
0.50 (people save half)0.95

Total income created: ₹446 → ₹500

₹100₹80₹64₹51₹41₹33₹26₹21₹17₹13₹100
Multiplier k5

ΔY = ₹500

Each ₹1 of new investment ends up as ₹5 of extra income, so ΔY = k × ΔI.

Spending in each round
RoundExtra spendingTotal so far
1₹100₹100
2₹80₹180
3₹64₹244
4₹51.2₹295.2
5₹40.96₹336.16
6₹32.77₹368.93
7₹26.21₹395.14
8₹20.97₹416.11
9₹16.78₹432.89
10₹13.42₹446.31

Working

  1. Round 1 spending = ΔI = ₹100
  2. Round 2 spending = ΔI × MPC = ₹100 × 0.8 = ₹80
  3. Limit = ΔI ÷ MPS = ₹100 ÷ 0.2 = ₹500, the same as k × ΔI

Common mistakes in the exam

  • k = 1 ÷ MPS, not 1 ÷ MPC.
  • For the change in income, ΔY = k × ΔI. Use only the extra investment ΔI here, not the whole investment I.
  • MPC can never be 1 or more. Some of every extra rupee must be saved.
  • MPC + MPS = 1 always, so MPS = 1 − MPC.

Find equilibrium income

Try an example:
Equilibrium income Y₹1,500
Multiplier k
5
Consumption C
₹1,300
Saving S (equals I)
₹200
ΔY = k × ΔI
₹250
New income Y
₹1,750
₹0₹0₹1,000₹1,000₹2,000₹2,000EADY

Thin line: AD = Y. Indigo line: AD = C̄ + I + MPC × Y. Where they cross (E) is equilibrium.

Working

  1. MPS = 1 − MPC = 1 − 0.8 = 0.2
  2. k = 1 ÷ MPS = 1 ÷ 0.2 = 5
  3. Y = k × (C̄ + I) = 5 × (₹100 + ₹200) = ₹1,500
  4. C = C̄ + MPC × Y = ₹100 + 0.8 × ₹1,500 = ₹1,300
  5. S = −C̄ + MPS × Y = −₹100 + 0.2 × ₹1,500 = ₹200, which equals I (₹200)
  6. ΔY = k × ΔI = 5 × ₹50 = ₹250
  7. New Y = Y + ΔY = ₹1,500 + ₹250 = ₹1,750

Common mistakes in the exam

  • Equilibrium is where output equals planned spending (Y = AD), not where saving is zero.
  • Check your answer: in equilibrium, saving must equal investment (S = I).
  • C̄ is the spending that does not depend on income. Do not add it in twice.
  • A tested income is only a check. The equilibrium is the value you worked out.
Money multiplier (LRR and deposits)

Money multiplier = 5

Money supply M = ₹5,000

Working

  1. Money multiplier = 100 ÷ LRR = 100 ÷ 20 = 5
  2. Money supply M = H × 100 ÷ LRR = ₹1,000 × 5 = ₹5,000
Budget deficits (revenue, fiscal and primary)
Revenue deficit
₹200
Fiscal deficit
₹550
Primary deficit
₹350

Working

  1. Revenue deficit = RE − RR = ₹1,000 − ₹800 = ₹200
  2. Fiscal deficit = (RE + CE) − (RR + non-debt capital receipts) = (₹1,000 + ₹400) − (₹800 + ₹50) = ₹550
  3. Primary deficit = Fiscal deficit − Interest = ₹550 − ₹200 = ₹350

Common mistakes in the exam

  • The fiscal deficit is the government’s borrowing for the year. It is not the same as the revenue deficit.
  • Leave out borrowings from the capital receipts. Only non-debt capital receipts count.
  • Interest is subtracted from the fiscal deficit to get the primary deficit. It is not added.

How the multiplier works

When ₹100 of new investment is spent, it does not stop there. It becomes income for the people who build, supply and sell. They spend part of it, and that spending becomes income for someone else. Each round is smaller, because part of every rupee is saved at each step.

The share of each extra rupee of income that people spend is the marginal propensity to consume(MPC). The share they save is the MPS, and MPC + MPS = 1. The multiplier is k = 1 ÷ MPS. With MPC 0.8, MPS is 0.2 and k is 5.

With MPC 0.8 and ₹100 of new investment, the rounds are ₹100, then ₹80, then ₹64, then ₹51.20, and so on. The total keeps closing in on ₹500, which is ΔI ÷ MPS.

Equilibrium income

Equilibrium is where output (Y) equals planned spending: AD = C̄ + MPC × Y + I. Solving this gives Y = (C̄ + I) ÷ MPS. Take C̄ = ₹100, MPC = 0.8 and I = ₹200: Y = 300 ÷ 0.2 = ₹1,500. The Keynesian cross shows this as the point where the AD line crosses the 45° line.

If the income you test is too high, planned spending is less than output. Unsold stock builds up, so firms cut production and income falls. If the income you test is too low, planned spending is more than output. Stocks run down, so firms produce more and income rises.

Money multiplier

The money multiplier is 100 ÷ LRR, where LRR is the legal reserve ratio in per cent. With an LRR of 20%, the multiplier is 5. In this simple model, ₹1,000 of high-powered money supports ₹5,000 of money supply.

Budget deficits

Revenue deficit = revenue expenditure − revenue receipts. Fiscal deficit = total expenditure − (revenue receipts + non-debt capital receipts). Primary deficit = fiscal deficit − interest payments. The fiscal deficit is the amount the government has to borrow in the year.

Learn the chapter

Learning aid — check the method with your textbook and teacher.

By the ACES team · Last checked 6 November 2026