The working of the multiplier process causes a larger increase in the income and output than the amount of increase in investment. But this manifold increase in income can come about only when some basic condition under which the multiplier works, are satisfied. If these favourable condition are not found in the economy, the multiplier process does not operate to cause any much larger increase in output and real income, but may lead to only an increase in money income and prices thereby causing inflation in the economy. The condition that must prevail in the economy for smooth operation of the multiplier are as follows:
For the multiplier process to operate, there must exist in the economy adequate amount of surplus labor. With the initial investment, income rises which leads to a larger expenditure on consumer goods, If additional labor is available for being used in the production of these goods, there will be greater output, larger employment and higher income which will further increase consumption and generate the further successive rounds of employment, output and income. But if the economy has no surplus labor and is already at full employment then further increase in employment and output are not possible due to non-availability of labor and hence the multiplier process will not work to increase output and employment, but will cause only increase in money income and prices.
For smooth operation of the multiplier process not only surplus labor should be available, but there should also exist excess capacity in the consumer goods industries. Excess capacity means that there should be machines, plants and equipment which are not being fully utilised. This is necessary because when demand for consumer goods increase due to increase in income consequent to increase in investment, the supply of theses goods could be increased accordingly. If all the machines and equipment are already being fully utilised and hence there is no excess capacity, then no further increase in the output of consumer goods is possible in the face of additional demand. Hence, no further increase in employment, production and income will take place and only price will rise, thereby hampering the process of multiple expansion of real income.
Along with labor and equipment, the working of multiplier presupposes adequate availability of raw material so that more of consumer goods can be produced in response to increase in their demand. If no more raw material is available, it will prove a bottleneck in expansion of output and thus impede the working of the multiplier process.
In brief, working of multiplier pre-supposes that labor, capital and raw materials are all available in plenty and are lying idle or unused due to lack of aggregate demand. Any increase consumption expenditure, which in turn further increase income, and so on the process goes on. But the limitation of labor supplies, non-existence of excess capacity in industry and inelastic supply of raw materials will prevent the operation of the multiplier and thus effectively limit the process of multiple expansion in output and income level in an economy.SUBMIT ASSIGNMENT NOW!