Economic Multipliers: Its Calculation and Usefulness

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Table of Contents

Introduction
The usefulness of a Multiplier
Income Multiplier
Output Multiplier
Employment Multiplier
Value Added Multiplier
Reference

Introduction

An economic multiplier is a figure used to approximate the economy-wide impacts of organisation-specific economic changes. Multipliers are generated from statistical or numerical models of a regional or national economy. Multipliers for every industry or business can be calculated by using models. A multiplier is a ratio calculated by dividing the approximate total effect arising from a given monetary shock to the economy by an essentially lesser partial effect, namely the activity-specific effect or direct project. 1This explains why a multiplier is always greater than one.

Every multiplier can be considered as an experiential, quantified determinant of the strength of the economic connections between a given economic sector or industry and the rest of the local economy. The extent of these linkages determines the size of the multiplier, i.e. the smaller the extent of the linkages, the smaller the size of the multiplier and vice versa. A greater multiplier translates to greater employment and the economy-wide dollar impact of any given stimulus to one sector or industry of the economy.

The usefulness of a Multiplier

There exist three major theories that must be understood to comprehend what lies behind the application of various multipliers. The first is the notion of an economic stimulus via a change in final demand. The second is the concept of a series of spending and respending provoked through an initial economic stimulus. The third is the concept of leakage from a regional economy.

Final demand implies selling economic goods and services to buyers who acts as final consumers of these products. In this case, the demand is final as opposed to it being intermediate. Goods and services are simply valued in and of themselves instead of their utility in the cost-effective production of new goods as well as services.

An increase in final demand triggers a sort of chain reaction in economic events. A sequence of extra spending and respending activities is set in motion by the initial stimulus of new spending. Largely, multipliers are applied with the presupposition that, in a defined mirror image of an increase, any reduction in existing final demand triggers a whole sequence of spending reductions.

A multiplier is a single numeral summarising overall economic benefits arising from a change in the regional economy. When used prudently, multipliers offer community leaders and planners the estimates of gross sales, income and employment that will emerge from new economic activity. Comparing the options will assist communities in deciding where to invest resources and time in order to acquire huge benefits. A multiplier will summarize overall impacts resulting from a change in specified economic activity. For example, an increase in exports by a regional organisation and new manufacturing facilities are economic changes that can prompt spin-off or ripple effects activities. Multipliers will estimate the new exports economic impact, as well as the consequential spin-off activities. Some planners may be principally concerned with income or employment, while others may want to measure the total value added to the regional economy.

Four multipliers are normally used to measure consequences of increased production arising from increased sales, commonly known as the final demand in multiplier analysis. The four multipliers are: Income Output, Output, Employment, and Value Added Multipliers.

Income Multiplier

The income multiplier estimates the total increase in income in the regional economy arising from a one-dollar increase in income received by employees in the exporting industry. When multiplied by the income multiplier, the initial income change gives a measure of the increase in income for everyone in the study region arising from the initial growth of one industry.

Output Multiplier

Output multiplier measures total change in regional sales, incorporating the initial $1 of sales outside the region, arising from a $1 increase in sales outside of the study area (final demand). Multiplying the increased sales from the exporting business by the output multiplier will give a measure of the general increase in sales for the study region, incorporating the $1 export sales. Thus, the output multiplier is used in measuring the interdependence of various sectors in the regional economy.

Employment Multiplier

Individuals always aspire to know the number of jobs created by a new economic activity. The employment multiplier estimates the overall change in employment arising from an initial change in employment of an exporting business. When multiplied by the industry’s employment multiplier, extra employment in the new activity gives a measure of the entire new jobs created in the region of study.

Value Added Multiplier

The value-added multiplier gives a measure of the extra value added to the product arising from a given economic activity. Value-added includes proprietary, indirect business taxes, employee compensation, and other property income

Reference

Branson, W. Macroeconomic Theory and Policy, Third ed. New York: Harper and Law Publishers, 1999.
Keynes, J.M. the General Theory of Employment, Interest and Money, London: McGraw-Hill, 1989.
Shapiro, E. Macroeconomic Analysis, New York: Macmillan Company, 2003.

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