'Multiplier Effect'

There is no denying the fact that the expansions of a country’s money supply that result from banks being able to lend in order to invest in the socioeconomic sector. The size of the multiplier effect depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.
The multiplier effect depends on the set reserve requirement. So, to calculate the impact of the multiplier effect on the money supply, we start with the amount banks initially take in through deposits and divide this by the reserve ratio. If, for example, the reserve requirement is 20%, for every $100 a customer deposits into a bank, $20 must be kept in reserve. However, the remaining $80 can be loaned out to other bank customers. This $80 is then deposited by these customers into another bank, which in turn must also keep 20%, or $16, in reserve but can lend out the remaining $64. This cycle continues - as more people deposit money and more banks continue lending it - until finally the $100 initially deposited creates a total of $500 ($100 / 0.2) in deposits. This creation of deposits is the multiplier effect.
The higher the reserve requirement, the tighter the money supply, which results in a lower multiplier effect for every dollar deposited. The lower the reserve requirement, the larger the money supply, which means more money is being created for every dollar deposited.
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.
The size of the multiplier depends upon household’s marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps). It is important to remember that when income is spent, this spending becomes someone else’s income, and so on. Marginal propensities show the proportion of extra income allocated to particular activities, such as investment spending by UK firms, saving by households, and spending on imports from abroad. For example, if 80% of all new income in a given period of time is spent on UK products, the marginal propensity to consume would be 80/100, which is 0.8.
The following general formula to calculate the multiplier uses marginal propensities, as follows:
1/1-mpc
Hence, if consumers spend 0.8 and save 0.2 of every £1 of extra income, the multiplier will be:
                1/1-0.8
                = 1/0.2
                = 5
Hence, the multiplier is 5, which means that every £1 of new income generates £5 of extra income.

The multiplier effect in an open economy

As well as calculating the multiplier in terms of how extra income gets spent, we can also measure the multiplier in terms of how much of the extra income goes in savings, and other withdrawals. A full ‘open’ economy has all sectors, and therefore, three withdrawals – savings, taxation and imports.
This is indicated by the marginal propensity to save (mps) plus the extra income going to the government - the marginal tax rate (mtr) plus the amount going abroad – the marginal propensity to import (mpm).
By adding up all the withdrawals we get the marginal propensity to withdraw (mpw). The multiplier can now be calculated by the following general equation:
1/1- mpw

Applying the ‘multiplier effect’

The multiplier concept can be used any situation where there is a new injection into an economy. Examples of such situations include:
  1. When the government funds building of a new motorway
  2. When there is an increase in exports abroad
  3. When there is a reduction in interest rates or tax rates, or when the exchange rate falls.
In view of the above, it is evident that multiplier helps the economy stable by virtue of the factors readily revitalized to strengthen the economic indicators to evaluate the problems where reforms strategy should be applied in due course.




Comments

Post a Comment

Popular posts from this blog

Irin, a mother of silent ocean

Image
A mother behind the deep sea and the ocean Walking past in the silent world of beauty and heaven,  She knows her work in motion and hurdles; Never hesitating through the rains and the clouds  In moving behind the shadow and perils of earth.  She remains happy by her unusual courage; To speak the truth in capsize haze and relies To switch the darkened cloud of the storm.  She walks past all along in the glowing streams  Underneath the big shades of the banyan tree As if the mother of all the child In the earth And the beams of light not under coercive strength. What she sees and explores in front of her  She is moving in her way to have bliss  Upon the supplication she always does.  She becomes remorse and dilapidated  when She hears the destitute of a motherless baby Her sorrows knows no bounds As if her heart always renders to restore the life of the child.  She is second to none to roll her tears  When sadness, pains and death stirs her.  L
Read more

Home, my sweet home

Home, My Sweet home There is no denying the fact that when our time comes to die, we should  not behave  like those whose hearts are filled with fear of death, so that when their time comes they weep and pray for a little more time to live their lives over again in a different way.  We should sing our death song, and die like a hero going home. The palpable image that comes to our cognizance when the expression ‘Home’ is perceived is of an edifice, chalet or a bed-sitter. A home cannot be just defined by a structure with a collection of rooms inside, for some it can also be their smartphones or even their refugee camp. According to Melody Bettie,” Gratitude unlocks the fullness of life. It turns what we have into enough, and more. It turns denial into acceptance, chaos to order, confusion to clarity. It can turn a meal into a feast, a house into a home, a stranger into a friend”.   A home is customarily distinct and comforting for any person but for realism of pedagogy, childr
Read more

Hooks Law and its application

Hooke's Law Hooke's Law states that, for certain elastic materials, force is proportional to extension, when a sample is stretched. This means that the extension of the sample increases linearly with the amount of force applied. Materials that obey Hooke's law are called Hookean Materials. Springs behave like Hookean Materials.Hooke's law can be written as  F = kx , where  F  is Force,  x  is extension, and k  is the Stiffness Constant of the sample. The stiffness constant describes the stiffness of a material, and is measured in Nm -1  (or Kgs -2 ). F = kx Hooke's law can be demonstrated with the use of Force-Extension graphs. However, no sample follows Hooke's law indefinitely, and there comes a point, called the Limit of Proportionality, where there is no longer a linear relationship between force and extension. After yet more force is applied, the Elastic Limit will be reached. This means that the sample will no longer return to its o
Read more