We all know from school that 2 + 2=4. But is this always true? And here we are faced with such a concept as a multiplicative effect. This is an economic term that shows how endogenous variables change in response to shifts in characteristics. The concept assumes that an increase in X by 1% leads to an increase in Y, for example, by 2%.
Concept
The multiplier effect is a concept that is most often associated with how investing in an economy (for example, increasing government purchases) leads to a much larger increase in employment and the production of goods and services than one might think. Let's see how it works:
- There is an investment in the national economy. For example, the state decides to increase the volume of purchases.
- Investment leads to an increase in aggregate demand for goods and services.
- This allows firms to use their production capacities more fully and hire more workers.
- Employment among the working-age population incountry is growing, people have more money.
- Aggregate demand for goods and services is growing.
Firms can hire even more workers by loading production capacity.
Calculation
There are several types of multiplier. The most famous is fiscal. The multiplier effect in monetary policy and in Keynesian models is also singled out separately. They talk about it when an increase in some indicators leads to a significantly greater increase in others. The calculation of the multiplier effect is always associated with finding the ratio of these changes. For example, the state increased purchases by 1 billion euros. Initially, aggregate demand, as we have already said, will also increase by this amount. However, in the end result it will grow by, say, 2 billion euros. In this case, the multiplier will be equal to 2.
Introduce the following notation:
- Y is the change in real GDP compared to the previous reporting period.
- J is the amount of additional financial injections into the economy.
- M – multiplier.
We can either take both of the first figures in terms of money, or as a percentage. So M=Y: J.
Considering what multiplier effects are, we have already mentioned that this indicator differs in fiscal, monetary and Keynesian models. The formulas are also different, although the essence itself remains the same. It is equal to the quotient of unity divided by the marginal ability to save. The formula allows you to understand howan increase in the money supply will affect the economy.
Example
Let's look at how tax cuts affect the economy:
- The economy is developing, the average annual growth rate is positive, and then the state decides to introduce VAT at the level of 15% (considering that earlier it was higher). There are no additional injections into the economy.
- Consumer disposable income is increasing.
- People get the opportunity to buy more goods, including expensive ones.
- Firms increase production due to the growth of aggregate demand, for which they hire new workers.
- As a result, we have an increase in employment, which means that people will be able to buy even more goods and services.
Money multiplier effect
In monetary macroeconomics, they study the influence of the money supply on the general conjuncture. If an increase in the monetary base by 1 dollar leads to an increase in the supply of funds by 10, then the multiplier is 10. Monetarists believe that it is impossible to influence the average annual growth rate through government purchases, which should increase aggregate demand. In their opinion, an increase in the disposable income of citizens leads to the fact that interest on loans becomes higher. And this means less investment from the business sector, which offsets the expected multiplier effect.
Monetarists insist on the need to increase money in circulation. The US Federal Reserve does this by changing the reserve ratio for commercial banks. Let's say it's 20%. This means that for every $100, 20 must remain in reserve. The bank can lend the rest of the money to someone else. The latter can also borrow them, having previously put 20% of the amount into his reserve account. This happens several times, which starts the economy, according to monetarists.
In fiscal policy
This is the most common type of multiplier. It's the easiest to understand. It is associated with the actions of the state, which are aimed at increasing aggregate demand. For example, the government may decide to cut taxes. This, as we have already said, will lead to an increase in demand for products, which will allow firms to use their production capacities more fully. Another instrument of fiscal policy is public procurement.
In the models of Keynes and Hansen-Samuelson
Gross product is an indicator of the efficiency of the economy. Representatives of the Keynesian direction do not agree with the monetarists regarding the inefficiency of increasing aggregate demand through fiscal policy instruments. They believed that during a recession there is significant idle capital in the business sector. Therefore, an increase in interest rates does not have such a negative effect on the economy. In Keynesian models, they usually look at how much the investment-savings curve shifts under the influence of changes in aggregate demand. The Hansen-Samuelson model goes even further. Grossa product is still a measure of the output of goods and services. However, Hansen and Samuelson consider the impact on it not only of investments, but also of economic cycles. They also introduce the concept of an accelerator. Scientists call the multiplier the excess of output growth over the increase in investment. The accelerator characterizes the increase in investments associated with the expansion of production. This is how the cyclicality of the economy can be conveyed. The Hansen-Samuelson model is dynamic, reflecting the development of the national economy under the influence of the market and government policy over time.
