The Economy & You #18 – Regional Multipliers continued

In my previous article, I wrote about the concept of regional economic multipliers. These multipliers estimate the effect a business expansion or plant closing would have on a local economy.  These multipliers project the change in economic output, income, and employment that results from a change in initial spending.

To calculate regional economic multipliers, economists construct input-output models to identify relationships among the different industry sectors within a regional economy. An input-output model is a mathematical description of how all sectors of an economy are related. In constructing an input-output model, economists separate economic activity into industry sectors to determine the value of goods and services as they flow from businesses which produce the goods and services to businesses that purchase them. Input-output models assume that for each industry in the region that a constant relationship exists between the value of the goods and services they produce and the value of goods and services (inputs) they purchase.  This assumption allows economists to quantify the economic impact estimate a business expansion will have on the region. 
In practice, the value of the regional multiplier is dependent on whether households are considered part of the interrelated industry sectors, or as a component of final demand outside the regional economy. Separating households from this valuation is subjective and will affect the estimated regional multiplier.

If households are included in industry sectors, then household spending is considered part of the multiplier effect because households earn income from the labor they provide businesses and the amount that consumers (households) spend is dependent on the income they earn.  If households are only considered as part of the final demand, then the income that is earned and the “respending” that occurs is not included in the total economic effect.

Therefore, multipliers that include households in the economic effect calculations are called “closed models” and the multiplier is larger than those “open models” that treat households only as part of the final demand.  Multipliers that are derived from open models are referred to as Type I or simple multipliers, while those derived from closed models are called Type II or total multipliers.

When regional multipliers are calculated there are usually three types of multipliers that can be derived: the standard output multiplier, an income multiplier, and an employment multiplier.  An output multiplier calculates the total value of sales of the regional economy needed to satisfy the demand resulting from the new business expansion or contraction.  This is the regional multiplier that is presented to quantify the effect of a new business coming into a regional economy.  Income multipliers estimate the change in regional household income by translating the effects of changes in demand into changes in household income.  Employment multipliers estimate the number of jobs that will be created from the created from a business expansion.  Most employment multipliers are estimated in terms of jobs and not full-time equivalent employees (FTEs). Unfortunately, the relationship between jobs and FTEs is not the same.  This is why comparison of employment multipliers is not always accurate.  Many times, they do not identify the mix of full and part-time workers.

While multipliers help to project the economic impact on a regional economy, caution must still be taken.  There are transitory effects in that multipliers estimate short-term economic changes. They do not take into account a regional economy’s long term adjustments.  In addition, multipliers used in impact studies are often generated on data based on transactions for a period that occurred five or more years earlier.  The cost to conduct a full survey to develop new input-output coefficients is very expensive. So existing models often use data that is several years old, and even if a new survey is conducted, it may take years to complete. A business may have significantly expanded or contracted since the survey was conducted which changes the data. Finally, relative prices for inputs may have changed which alters purchasing patterns. Because of these challenges, economic impact estimates may be inaccurate. 

Regardless of the challenges of timely data and projecting business production and purchasing patterns, the input-output models assist in describing the economic changes that are likely to occur as a result of a single event    within a relatively short period of time.  It is this information that helps decision makers and local residents decide whether a proposed development project is in the best interests of their community.

Related articles

• The Economy and You: CPI and Inflation (wistatetreasury.wordpress.com)

January 11, 2012 | Categories: Economy, Financial Education | Tags: economic multipliers, Economy, multiplier effect, output models, State Treasurer, State Treasury, wisconsin, Wisconsin State Treasurer | Leave A Comment »