Multiplier effect

DEFINITION of multiplier effect

The multiplier effect is an effect in economics in which an increase in spending produces an increase in national income and consumption, greater than the initial amount spent.

WHAT IT IS IN ESSENCE

In simple, It is the number of times a rise in national income exceeds the rise in injections of demand that caused it.

In simple, It is the number of times a rise in national income exceeds the rise in injections of demand that caused it.

The concept of the multiplier process became important in the 1930s. John Maynard Keynes suggested it as a tool to help governments to maintain high levels of employment

This “demand-management approach”, is kind of help to overcome a shortage of capital investment. It can measure the amount of government spending that is necessary to reach a level of national income that would prevent unemployment.

For example, a corporation builds a factory. So, it will employ construction workers and their suppliers as well as those who work in the factory.

 Indirectly, the new factory will stimulate employment in laundries, restaurants, and service industries in the factory’s vicinity.

Every time there is an injection of new demand into the circular flow there is likely to be a multiplier effect. This is because an injection of extra income leads to more spending, which creates more income, and so on.

The multiplier effect refers to the increase in final income arising from any new injection of spending.

HOW TO USE

Example:

The multiplier effect can arise in many different forms, but bank lending is a common example.

The customer deposits cash into a bank. Hence, the bank has to keep a certain portion of it but is free to loan the rest out to other customers.

Above all, those customers can spend the cash. And it will eventually end up being deposited in another bank.

Part of the new deposit will be reserved by the new bank. But part of it will be loaned again. And all because of the reserve requirement. This process will carry on until eventually all of the initial deposit find its place back in banks.

By this process, the initial deposit has been deposited and used multiplied several times.