How accurate is the multiplier?

Just covering the multiplier with my A2 and will be later with my NCEA Level 3 class. Think of the multiplier effect as a still pond. Women’s Football World Cup being held in Australia and New Zealand later this year – the direct impact of spending on the World Cup is like a stone hitting the water and creating ripples which will get smaller and smaller. With spectators coming to Auckland to watch a game they will make additional spending on accommodation, transport, food, tourist attractions etc. Where a hotel makes a lot of money form the event they may chose to extend the numbers of rooms which means they will have to employ contractors who will receive more income. The contractor might spend this additional income on a new vehicle for the business which then adds income to the car dealership – and it goes on with the ripples getting smaller and smaller.

Economic forecasters tend to use a simple formula to estimate the multiplier effect of sports event. They will estimate the number of spectators, how long they will stay and what they, on average, will spend whilst at the event.

Problems of forecasting
Unrealistic projections of the number of visitors or their potential spending will lead to inaccurate multiplier effects. Factors that might overestimate the true economic impact of a sporting event.
Substitution effect: this happens when the spending on a sporting event would have been spent elsewhere in the local economy and therefore doesn’t generate new economic activity.
Crowding out: crowds and congestion may dissuade other economic activity from occurring. For example London Olympics 2012 590,000 visitors arrive in connection with the Olympics but the number of visitors fell by 1 million between summers of 2011 and 2012.
Leakages: higher costs for restaurants, hotels etc associated with hosting the event doesn’t necessarily mean that employees working in those areas will be paid more. Also where there are guest workers from overseas the money is less likely to be recirculated. For some venues on the coast cruise ships have been used but this is only during the event.

Research into the impact of sporting events whether it would be the Champions League Final, World Cup, Olympic Games etc has found there is little short-run economic effect on the host city. The table above shows the research before and after sporting events with conflicting data. Some economists joke that if you really want to know what the true economic impact of a sporting event is, just take whatever number the promoters give you and then move the decimal point one place to the left.

Source: The Economics of Sport (2018) – M. Leeds, P. Von Allmen and V. Matheson

The theory behind the multiplier.
Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM

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Keynes v Monetarist – Powerpoint download

Currently covering Keynes vs Monetarist in the A2 course. Here is a powerpoint on the theory that I use for revision purposes. I have found that the graphs are particularly useful in explaining the theory. The powerpoint includes explanations of:

C+I+G+(X-M)

• 45˚line
• Circular Flow and the Multiplier
• Diagrammatic Representation of Multiplier and Accelerator
• Quantity Theory of Money
• Demand for Money – Liquidity Preference
• Defaltionary and Inflationary Gap
• Extreme Monetarist and Extreme Keynesian
• Summary Table of “Keynesian and Monetarist”
• Essay Questions with suggested answers.

Hope it is of use – 45˚line shown. Click the link below to download the file.
Keynes v Monetarist Keynote

Automatic stabilisers – Direct Stimulus Payments

It is unavoidable that recessions are part of the economic environment that we live in. In tackling the impact of recessions it has become apparent that one cannot solely rely on expansionary monetary policy of the central bank. Economic conditions have changed, as if an economy was to fall into recession in this low interest environment monetary policy options are far more limited than they were post the GFC. Add to this a higher debt level and you put further pressure on the banking system. A publication this year entitled “Recession Ready – Fiscal policies to stabilise the American economy.” (Published by the Hamilton Group – Washington Center for Equitable Growth) suggests that governments should assist in ensuring that the recovery phase is much quicker than it has been by ensuring confidence amongst businesses and households so they resume investing and spending again. They focus on antirecession programmes known as “automatic stabilisers.”

Automatic stabilisers are the automatic increases in revenues and decreases in expenditure in the government budget that occur when the economy strengthens, and the opposite changes that occur when the economy weakens.

Increase in GDP growth = the government will receive more tax revenues – people earn more and so pay more income tax. As it is assumed that unemployment decreases the amount of money spent on unemployment benefit decreases.

Reduction in GDP growth = lower incomes – people pay less tax. As unemployment increases the government spends more on unemployment benefits. This increase in benefit spending and lower tax collection helps to limit the fall in aggregate demand.

One of the chapters written by Claudia Sahm proposes a direct payment to individuals that would automatically be paid out early in a recession and then continue annually when the recession is severe. During a recession consumer spending (C) declines sharply – see graph – and as it makes up above 70% of most countries aggregate demand – C+I+G+(X-M) – this can lead to employment losses and reduced output. Consumers therefore are integral to boosting aggregate demand and direct stimulus payments to individuals should become part of the system of automatic stabilisers as additional income translates quickly into additional spending.

Trigger to start automatic stimulus payments.

The idea behind this is for direct payments to individuals after a 0.5% in the quarterly unemployment rate. If you look at each recession since 1970 the stimulus trigger of an increase in 0.5% unemployment meant that payments would have been triggered within three months of the start of the past six recessions (USA). But there are some concerns with using unemployment data:

1. Unemployment rate tends to lag the business cycle as unemployment tends to peak after the recession ahas ended.
2. The rise in unemployment doesn’t necessarily mean you are in recession – two consecutive quarters of negative GDP.

Lump sum v Tax cuts

There is an argument that a one-off lump sum payment is much effective in boosting spending than changes in income tax which would be spread fiscal stimulus throughout the year. Even if the Marginal Propensity to Consume (MPC) was the same for both lump sum and tax cuts it would not be until early in the next year that the full spending occurred under the tax cut option. The delay in spending from lump sum payments would be three months thus the overall stimulus boost would be both larger and more rapid – see graph below.

Final thought
Direct stimulus payments would quickly deliver extra income to millions of households at the start of a recession and maintain income support until the recession has subsided. This should generate more aggregate demand and thereby reducing the impact of the recessionary phase.

Source: “Recession Ready – Fiscal policies to stabilise the American economy.” (Published by the Hamilton Group – Washington Center for Equitable Growth)

Football stadiums and economics

With the start of the EPL this weekend I thought it appropriate to look at something related to football. Teams in the EPL and other domestic leagues often look for funding from the government to build stadiums with the rationale that the investment will attract consumers and businesses to the local area. This suggests that a multiplier effect would be at work and the benefits to the area go beyond that of the football field.

The size of the multiplier is influenced by how much of extra income is spent on domestically produced products. The more that is passed on in the circular flow, the larger will be the multiplier. This means that the size of the multiplier varies inversely with the tendency for extra income to be withdrawn from the circular flow – the marginal propensity to withdraw. It is calculated by 1/marginal propensity to withdraw. In the case of a two sector economy, this is I divided by the marginal propensity to save (mps). For example, if people save $20 out of an increase in income of $100, the mps will be 0.2 and the multiplier will be 1/0.2 = 5.

Cities with new stadiums initially create jobs and growth but in the long-term there is little economic benefit. Why?

1. For all their cultural significance, sports tams are not very big businesses and so their overall impact is small in most cities of any size.
2. If local residents spend more at the stadium they are likely to reduce spending elsewhere which will impact on local businesses.
3. A stadium may attract more visitors from outside the area who inject money into the local economy, but the multiplier effect is likely to be small because many of the services they consume will actually come from outside the area – e.g. food and beverages may be shipped in from elsewhere.

If you look at previous World Cups or European Championships there tends to be the same issues as mentioned above

The 2010 World Cup in South Africa saw Soccer City, the largest sports venue in Africa, undergo a £300 million renovation which costs £250,000 a month to maintain. It is the stadium for the Kaizer Chiefs and Orlando Pirates but is rarely full and has struggles to make revenue from other sources. See below:

Brazil spent about $3 billion building 12 new or heavily refurbished stadiums for the 2014 World Cup. Officials justified the expense by saying that the stadiums would generate revenue for years to come with Brazilian football premier league games and rock concerts but most stadiums are failing to generate any revenue. The most expensive stadium in Brasilia – 72,000 seater and a $900 million venue – is used a bus parking lot. A big issue here was that there was no major professional football team in the city so therefore limited crowds would be present. Although the organisers rationale was to improve facilities around the country there are white elephants evident – in some locations teams cannot afford the rental so will play at much smaller venues. A $600m stadium in Manaus was used for 4 World Cup games but is now empty which is not surprising as the city itself has a lower division football team who don’t have the finances. What people forget is that, although the stadiums might look good and are used to host the biggest sporting event in the world, a large number of people are displaced and neighbourhoods disestablished. But organisers say that it will add to the well-being of the population especially if the host side wins – however this has not been the case for Brazil – in fact as we know it turned out to be a bit of a trashing in the semi-final against Germany. It will be interesting to see the use of stadiums in Russia after the World Cup just gone but one cannot doubt that the morale of the Russian people was significantly boosted by their teams performance.

Volvo Ocean Race and the Multiplier Effect.

I am quite an avid watcher of the Volvo Ocean Race with the daily race updates and the excellent graphics on their website – currently they are in Auckland before setting sail for Itajaí in Brazil. Most days they have news on the current positions of the yachts and who has made gains and losses in the last 24 hours. A recent race update dealt with the economic impact that the race has had on the Spanish economy and it just happens that I am covering the multiplier with my A2 Economics class.

The Multiplier Explained

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM

Source: CIE Revision Guide by Susan Grant

Impact of Volvo Ocean Race on Spanish Economy

PriceWaterhouseCoopers (PwC) conducted a study measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain. Some their findings are:

• The impact in the Region of Valencia has grown to 68.6 million euros in GDP and 1,270 full-time equivalent jobs.
• Hotels, restaurants and local business were the sectors to benefit the most.
• Alicante received 345,602 visitors from October 11 to 22, 2017, (10.3% more than in 2014-15 and 17.6% more than in 2011-12).
• The Volvo Ocean Race had a significant positive effect on national tax revenue, adding more than 41 million euros.
• The media value directly linked to coverage mentioning the Alicante brand over the period of the race start exceeds 36 million euros.

The Volvo Ocean Race 2017-18 has added 96.2 million euros to the Spanish Gross Domestic Product (GDP), an increase of 7.6% over the 2014-15 edition. The race also generated the equivalent of 1,700 full time jobs in Spain, according to an economic impact study delivered by PriceWaterhouseCoopers (PwC) measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain.

The impact in the Region of Valencia grew to 68.6 million euros of GDP, a 3.3% increase on the 2014-15 edition. The sectors of activity that benefited the most were local businesses and restaurants, each by more than 10 million euros. In terms of employment, the equivalent of 1,270 full-time jobs were generated, a figure similar to the last edition.

The PwC study estimates a positive effect on tax collection in Spain of more than 41 million euros as a result of an increase in economic activity and employment generated by the Volvo Ocean Race 2017-18.

The actual value of the multiplier is not mentioned in the report but from all accounts the Volvo Ocean Race has had a very positive impact on Valencia.

The Multiplier explained

An initial change in AE can have a greater final impact on equilibrium national income. This is known as the multiplier effect and it comes about because injections of demand into the circular flow of income stimulate further rounds of spending.

Multiplier Process

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realize an increase in their

incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)

You can also use the following formula which represents a four sector economy

1 ÷ MPS+MRT+MPM

MPS = Marginal propensity to save

MRT = Marginal rate of tax

MPM = Marginal propensity to import

MPC = Marginal Propensity to Consume (of additional income how much of it spent)

e.g. $1m initial spending; MPC=.8

=> income generated = 1/(1-.8) = 1/.2 = 5

=   $5m

=> $4m extra spending ($1m initial, $4m extra spending, $5m total)

Use different equations depending on the information given.

e.g.: a) if the MPC is 0.5 – 50% of the income will be spent, 50% will be saved.

then MPS is 0.5 then the multiplier is 2 = 1/0.5 = 2

b) if the MPC is 0.8 – 80% of the income will be spent then MPS is 0.2 then the multiplier is 1/0.2 = 5

c) if the MPC is 0.9 – 90% of the income will be spent then MPS is 0.1 then the multiplier is 1/0.1 = 10

What is the effect of MPT – the marginal propensity to tax or t.

• greater MPT would lead to less income being spent in the economy

Below is a very informative mind map that I copied from an old textbook.

US infrastructure could create those jobs

Some alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.