The Multiplier Effect

Here I am to present more about the ideas about the Money Multiplier Effect that was covered today in Econs Lecture.

Ok, we need to simplify matters abit. Say that in my mini-economy, I have yihong who is holding a job as a butcher, Ernest holding another job as a fish-monger, Kahyan holding a job as a tailor, Adeline as a fashion designer. One person's revenue is another's expenditure.

Imagine me, the government, going to yihong to buy $100 worth of meat. This is part of my government spending to kick start the dying ashes of my economy. So yihong now as extra $100 income. Imagine we do not have leakages, that is almightly benevolent me does not tax my peasants, neither do my peasants save. So yihong went to market, met Ernest the fish-monger, and using that $100, bought 20 fishes home. So now, Ernest has extra $100 income.

Ernest went to Kahyan, to get his shirt patched up, and paid her $100 for her services. Kahyan now has extra $100 of income. Kahyan went to Adeline the fashion designer to buy new designs, and paid Adeline $100 dollars.

Adeline went to yihong to buy meat, and paid yihong $100 dollars....Amazing, you have $100 that buy meat, fish, cloth, designs, meat, fish, cloth, designs,meat, fish, cloth, designs, ad infinituum. So you see, this $100 is very mighty indeed. It bought a lot of goods and services and would have continued to buy more stuff.

This is the multiplier effect at heart. In a economy with absolutely no leakages, the $100 could buy up to an infinite amount of goods and services. But of course, reality isnt so rosy. So we got savings, we got taxes, and shipping money to other countries, etc. So, each round, we only like spend, eg 50% of the income.

Actually the equation describing this phenomenon is the GEOMETRIC PROGRESSION. Yep, the good old GP that we learnt in maths last year. Since the percentage of income that we spend is less than 1, than mathematically speaking, taken to infinity, this multiplier effect must stop eventually because sum of the series will converge on some value. Though the equation is not to be studied at H1 level, I am very sure that if every one saw the equation for the multiplier, they would exclaim in recognition.

Oh, btw, in my mini-economy, I spent my way out of the recession. Spend , spend, spend. Go and get that pair of shoes that you have been eyeing for ages! It might spur the economy. Who knows? The Butterfly Effect.