The multiplier effect in economic parlance

The multiplier effect is an economic term, referring to the proportional increase, or decrease, in final income that results from an injection or withdrawal of capital.

In effect, multiplier effects measure the impact that a change in an economic activity like investment or spending will have on the total economic output.

Generally, economists are most interested in how infusions of capital positively affect income or growth.

Many economists believe that capital investments of any kind whether at the governmental or corporate level will have a broad snowball effect on various aspects of economic activity.

As its name suggests, the multiplier effect provides a numerical value or estimate of a magnified expected increase in income per dollar of investment.

Economists use models to estimate the net impacts of a change in the economy. In the case of economic multipliers, the most common tool is called an input-output model.

This model attempts to correlate activities across industries, which then allows a change in one sector to flow through every other sector. For example, if a $1 million government project gets funding, the model spreads that $1 million across the sectors that receive that money.

For instance, the construction industry may receive $650 000. The construction industry pays $500 000 to construction workers, who, in turn, spend $400 000 on retail products.

That $400 000 flows down to wholesalers, farmers, and retail workers. In this way, the initial capital spend flows through the economy, impacting sectors far removed from the direct recipients of the funding.

In theory, that implies that the money supply can be expanded by 10 times more than the original injection. When money gets injected into an economy, three stages increase the amount of economic activity and can be elucidated below.

Direct impact

The first-order effects of injection are what is directly visible. For example, a government stimulus check of US$1 million per person will obviously increase the income of everyone receiving that check. That is the direct impact as evidently indicated.

Indirect impact

But the stimulus check does not stop with the people who get the money. They go out and spend it, which leads to increased consumer spending. If people use their stimulus check to go out to eat, that might cause restaurants to hire more cooks and waiters/waitresses. These are the second-order impacts of the initial injection.

Induced impact

But the money does not stop there either. Those additional wait staff end up with more income than they previously had. And they are likely to spend it. Perhaps they use that money to buy groceries, pay bills, and put fuel in their cars.

Consequently, the grocery store, bills companies and gas stations see an increase in revenues. These are induced impacts that flow from that initial injection of cash.

Many economists believe that new investments can go far beyond just the effects of a single company’s income. Thus, depending on the type of investment, it may have widespread effects on the economy at large.

A key element of Keynesian economic theory is that of the multiplier, the notion that economic activity can be easily influenced by investments, causing more income for companies, more income for workers, more supply, and ultimately greater demand.

Essentially, the Keynesian multiplier effect is a theory that states that the economy will flourish the more the government spends and the net effect is greater than the exact dollar amount spent.

Different types of economic multipliers can be used to help measure the exact impact that changes in investment have on the economy.

For example, when looking at a national economy overall, the multiplier would be the change in real gross domestic product divided by the change in investments, government spending, changes in income brought about by changes in disposable income through tax policy, or changes in investment spending resulting from monetary policy via changes in interest rates.

Economists and bankers often look at a multiplier effect from the perspective of banking and a nation’s money supply. This multiplier is called the money supply multiplier or just the money multiplier.

The money multiplier involves the reserve requirement set by the Reserve Bank of Zimbabwe and it varies based on the total amount of liabilities held by a particular depository institution.

The money supply multiplier effect can be seen in a country’s banking system. An increase in bank lending should translate to an expansion of a country’s money supply.

The size of the multiplier depends on the percentage of deposits that banks are required to hold as reserves. When the reserve requirement decreases, the money supply reserve multiplier increases, and vice versa.

The multiplier effect has several implications on an economy. First, the multiplier effect often has a positive impact on the economy and economic growth.

Instead of being limited to the actual quantity of funds in possession or in circulation, the multiplier effect can scale programs and allow for more efficient use of capital.

Multiplier effects may also impact economies in different ways. First, economies experience direct impacts when an economic factor is directly attributed to an entity. For example, when a government awards a tax incentive to an individual, that individual is said to have received the direct financial impact.

However, the multiplier effect incorporates two additional impacts: the indirect impact and the induced impact. The indirect impact of the government benefit above is that the individual takes their tax benefit and spends it.

These funds do not sit idly by in one bank account; they may be spread across a dozen different businesses potentially relating to grocery stores, restaurants, car dealerships, or online purchases.

Multiplier in Four Sector Economy

The four-sector economy is made up of households, firms, the government, and the foreign sector. Money flows through these four sectors through government spending and investing, taxes and private income as well as imports and exports in a circular flow.

Leakages consist of taxes, savings, and imports because the money spent on those does not continue to circulate in the economy.

Injections are exports, investments, and government spending because they increase the supply of money flowing through the economy. The multiplier effect can be applied to several components. Firms and households account for the autonomous change in aggregate supply.

Blessing Nyatanga holds a Bachelor’s degree in Banking and Investment Management from NUST.0784909184snyatanga@gmail.com-ebusinessweekly