The introduction of multiplier analysis in income theory is regarded as one of path-breaking contributions of Keynes to the economic theory. It is not merely theoretical concept, but also important instrument of economic policy. The importance of multiplier can be explained as follows:
(1) Importance in Investment:
The concept of multiplier established the immense importance of investment as the major dynamic in pretence of investment as the major dynamic element in the economy. J.M. Keynes considers the theory of multiplier as an integral part of the theory of employment. The multiplier, he says, ‘establishes a precise relationship, given the propensity to consume (MPC), between the aggregate employment and income and the rate of investment’. Thus, it underlines the importance of investment and explains the process of income propagation.
(2) Analysis of Trade Cycle:
Cyclical fluctuations or business cycles characterized by alternating waves of expansion and contraction are the inherent features of market economies. The multiplier process by showing different phases of trade cycles helps the business to plan their transactions accordingly.
(3) Equality between Savings and Investment:
It helps in bringing the equality between saving and investment. If there is a divergence between saving and investment, an increase in investment leads to a rise in income with the multiplier process by more than the increase in investment. As income increases, savings also increases and equals investment.
(4) Formulation of Economic Policy:
The multiplier analysis is an important tool in the hands of modern governments in formulating economic policies and projecting their consequences. It can be used to estimate the quantitative government policy changes needed to smooth out some of the business cycles.
(5) Importance of Public Investment:
The modern governments decide upon the amount of investment to be injected in to the economy so as to utilize the idle resources and remove unemployment. With the help of multiplier analysis policy makers project the required levels of investment to be made till the full employment level is reached.
(6) Deficit Financing:
The multiplier principle highlights the importance of deficit financing. When the economy is reeling under a state of recession increased government spending through public investment programs, creates a budget deficit and helps in expanding income and employment by multiplier times the increase in investment.