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The Concept of the National Income Multiplier Term Paper

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The concept of the national income multiplier states that an initial rise in money injection into the national income (or spending) is likely to result in further spending (Miller 2000). Hence, the final rise in the national income is much more than the initial injection (the initial spending). For example, if the government raises its spending on infrastructure by $1billion, the national income goes up by the same amount. If the infrastructure is built and used to generate more income, say $1billion, the final increase in the national income will be $2billion. Therefore the national income multiplier effect will be 2; that is, 2/1=2.

The multiplier effect can therefore be said to be the impact of an initial change in aggregate demand on the national income equilibrium. It is a result of injections of demand (spending) into the national circular flow of income, and which stimulates further demand or spending. According to Miller (2000), the multiplier process may continue throughout, increasing after every increase in spending. However, the additional increase in spending is determined by the previous increase in the circular flow of national income. For instance, the national income increased from $1billion to $2billion as a result of spending on infrastructure. If the spending increases further by $1billion, the national income rises to $3billion and the fraction of the increase becomes 2/1*$3billion=$6billion.

The national income multiplier in respect to Keynesian economics

Keynesian theory of national equilibrium states that the multiplier process is an appropriate way towards achieving a full employment level (Harris 2005). This is an effective way of measuring the amount of government expenditure that is required to reach that level of national income that will not result in unemployment. In the Keynesian theory, the more the marginal propensity to consume, the higher is the multiplier effect. According to Chacholiades (2007), factors that affect the multiplier effect include:

  1. Government activity, for example, through altering the direct taxes. A reduction in the rate of income tax will raise the ability of people to consume (propensity to consume) other goods and services and this will, in turn, raise the national income multiplier.
  2. The propensity to import. Reducing import tariffs or creating more favorable conditions to import goods and services will lower the multiplier effect because the extra income is used on imports which do not impact the domestic national income.
  3. The elasticity of aggregate demand and aggregate supply: In order to produce additional output, then there must be enough extra capacity to take in the additional output. The economy is unlikely to experience the multiplier effect if the aggregate supply is inelastic or is not affected by a change in demand.

The concept of the national income multiplier effect can be represented in form of a diagram as follows. It is a representation of how national income is affected by the conditions of supply and demand and which in turn results in a change of the national income multiplier effect (Harris 2005).

AD1 is the initial aggregate demand curve at price P1. An elastic aggregate supply curve is likely to lead to a high change in the national income. The Short-run aggregate supply curve (SRAS) in the diagram above is relatively inelastic and a change in the price of goods and services from P1 to P2 results in a less than proportionate increase in the national income. This is because of the inelasticity of the aggregate supply curve. The aggregate demand is affected by the price rise and the AD curve shifts from AD1 to AD2.

How the concept of national income multiplier can be used to clarify the impact of the Olympic games of 2012 on the UK economy

The OECD Economic Survey: UK (2005) points out that, a rise in the UK investment will result in a rise in national income, and this will, in turn, raise the multiplier effects. The 2012 Olympic Games are a form of investment to London and to the UK in particular. They are likely to increase government spending through infrastructural development. For instance, the Lower Lee Valley is one of the priority sections that the government intends to re-develop. This area is characterized by poor infrastructural facilities like housing and roads and high levels of unemployment. If the government regenerates this area, the level of unemployment will go down and this can be proved by identifying the amount of government expenditure that will be used to develop the Lower Lee Valley and in turn raise the national income to a level that will not result in unemployment. Government injection through the construction of better housing facilities will also raise the level of spending and in turn, increase the national income which will have an effect on the multiplier.

The London Government Agency has come up with an estimate of the having an establishment of nine thousand new houses in the UK. The construction of these facilities will provide jobs prior to the Games. If the concept of the national income multiplier can be used, the creation of jobs is a result of an increase in the aggregate supply and this has supplied is likely to fulfill the increased demand for job opportunities. This will result in an increase in the level of national output through a rise in the income per capita (Morris 2007).

The Olympic Games are also expected to raise the spending of individuals through transport, accommodation, meals, entertainment, and other expenditures incurred by both the spectators and the athletes, among other parties. In the national income multiplier, the spending of foreigners has no effect on national income and therefore this must be taken into consideration while determining the total spending incurred during this period (Morris 2007). Morris (2007) argues that, by implementing the concept of the national income multiplier, the country will be able to determine the extent to which spending on individuals will affect its economy while distinguishing between spending on residents and on non-residents.

The impact after the Olympic Games which can also be referred to as the legacy effect includes the long-term benefits the country will have on the infrastructural facilities developed. They will provide value to the country’s economy in the future and they can be used to generate more income which will result in the higher national income multiplier effect. Despite the fact that the government will have to incur great expenditures in the development of the Olympic infrastructures, the spending will be a form of an injection to the national income and once the Games are over, the country will be able to use these infrastructures to develop other sectors like business investments. Therefore, with the concept of the national income multiplier effect, spending in the Games will lead to other impacts after the Games and will be a way to improve the country’s economy (Harris 2007).

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