How does the "multiplier effect" work in economics. Will we all be rich eventually?

Question

They say some people have more money than sense. Will there come a day when there will be so much of it, "they will be giving it away"? How does the multipler effect work and when in the future, will all be born millionaires?

Answer 1

The multiplier effect occurs when there is an injection of cash into the economy (or a withdrawal: negative multiplier).

Imagine the government decides to use some of its reserves to build a new bridge. It takes money from the reserves and buys the raw materials and pays the workers. Let's focus onthe salaries to workers.

Say each worker is paid $100. Then each saves $10, and spends the rest on pies. From each worker, the pie shop owner has $90 extra, and let's say she saves $9 of it, and spends $81 on say milk. The farmer receives $81 which started as $100 from the worker, but out of which $19 was saved, $10 by the worker and $9 by the pie shop owner. If the trend continues, say the farmer saves $8.10 and spends $72.90 on seeds...

From the original $100 per worker spent by the government, the worker spent $90, the pie shop owner $81, the farmer $72.10... Therefore the $100 per worker spent by the government hasthus made income grow by more than $100, hence the name multiplier. If at every stage the person earning keeps 10% of what he/she earns (marginal propensity to save = 10%) then the overall effect will be that $100 will increase income by 100*(1/10%) = $100*10 =$1000. The multiplier is 10.

Of course this isa very simplistic story, assuming all the money remains in teh domestic economy and so on....

Now a small injection like $100 is unlikely to change much in the larger picture. But imagine every worker is given $10000. This will make many people want to buy manythings. The amount of stuff people will want to buy at all prices will increase since they have more money to spend.

However, the amount of stuff on the market cannot instantly appear on the shelves.

Therefore at current prices, quantity demanded will exceed quantity supplied, and prices will rise.

This increase in prices will decrease the real value of what people earn. Previously may be $1000 could buy 200 pies; but as people want to buy more pies while the pie makers cannot produce so much instantaneously, the prices for pies will rise, and $1000 might only be able to buy you 100 pies. (That's inflation)

Therefore prices rise to negate the multiplier effect to some degree. (The exact degree is a matterof hot debate)

What I am trying to get at is that may be in monetray terms we are richer, but in terms of what we can buy (which is what really matters) we are not necessarily able to buy that much more. Therefore, even if at some point there has been so much injection and prices have risen so much that we are all millionnaires, it doesn't mean we are better; it's just that prices have risen. In real terms we are as poor/rich. It's just like the government saying that from today all bank balances multiply by 1000, but so do all prices... It makes no difference to what you can or cannot buy. And chances are, nobody will be giving money away.

Answer 2

The multiplier effect is a limited economic concept. Based on two flawed concepts:
- "Money" appears from nowhere, yet is valued. Printing money will just increase prices (inflation). Debt must be borrowed from somewhere, so borrowing money to encourage consumption will be offset by higher interest rates and more saving. Considerring that most everything that is suppose to cause a multipier effect will be cancelled out in a more extensive model.

-A multiplier assumes that the market isn't efficient for some reason. If the labor market is relatively inelastic, a large multiplier seems unreasonable. Basically, if people either get money from the government or higher wages they may decide to work less (income effect), but they won't decide to work excessively more as the multiplier effect would suggest.

Basically, multiplier effects are really bad economics at least according to the neo-classical school. The idea that people simply getting money and spending it is an oversimplification of what really happens. We won't all be millionaires and if we do all become millionares we will be paying thousands of dollars for a Big Mac.

Answer 3

Multiplier Effect Example

Answer 4

Because you do not realize that the top 25% of the wage earners pay about 75% of the taxes already. The bottom 50% pay a whole 3%. So how is increasing the top earners going to do anything when it has been proven that tax increases reduce the national revenues from those taxes? Meaning those with the higher wages will take their business out of the country where they can make more, thereby reducing jobs for those who need them to survive. Since Bush's tax cuts where NOT just for those making over 250K, but Obama's proposed increases were for those making over 250K, but with all the bills recently passed will cost those making less more in actual product costs. Yup great idea, put more financial stress on those who were the "middle-class" by expiring the tax cuts. You might want to do more research on this matter.

Answer 5

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RE:
How does the "multiplier effect" work in economics. Will we all be rich eventually?
They say some people have more money than sense. Will there come a day when there will be so much of it, "they will be giving it away"? How does the multipler effect work and when in the future, will all be born millionaires?

Answer 6

The multiplier effect says that if a government stimulates the economy by reducing tax and interest then they will increase disposable income which people will spend. This increases demand which increases employment, which increases revenue which creates wealth for the country as well as for its citizens.

The alternative view suggests that government must charge more tax to balance its books but this can actually reduce revenue by surpressing demand and thus surpressing employment.

Answer 7

the faith in the multiplier effect is another example of what happens so often in economics: looking at the parts not the whole
it is obvious immediately, from looking at the whole, that the multiplier effect has to be wrong, as, i suspect, you noticed - i think you noticed that it is a sort of pulling yrself up by yr bootstraps fallacy - it is true that lower taxes will increase disposable income, increase buying, increase employment, etc - & there are ppl who will run away with this - & ppl who will use it as a 'reason' to lower taxes [mostly on the rich] - human life is a comedy of errors - failing to see the obvious bigpicture because of tunnelvision, seeing parts, thinking smthg is good which is bad
it is pretty obvious to a dispassionate unselfdeceiving selfinterest that the only thing that makes wealth is work - work increases the size of the waterbed [= economic pie, fruits of labour] - making economic elements go up or down just jiggles the waterbed - lowering taxes will make other econ elements go up or down, but if the bed gets a chance to settle [or if it doesnt], it will be the same size
[every jiggle of the waterbed is an opportunity for financiers to pump money from the nation to their pockets - 'the poor man [the only maker of wealth, by work] pays for all']
i think you saw that if the multiplier works then it follows that in time we will have to all become rich - just by lowering taxes - economics is almost nothing except a list of selfdeceptions driven by hope of wealth & tunnelvision [we have predator vision [focussing vision, not 360 degree vision], so we cant see when we are prey, ie we cant see downsides of things] - starting with the father of all economics non-sense: that the private selfinterest of the merchant helps everyone - a comedy, but a tragedy too - 2 million/yr going blind for lack of 4c of vitamin A/yr - millions of landmine victims - a million girls sold into sex slavery/yr - 1 in 50 humans killed by war & starvation/yr - violence [war & crime] & pay inequity escalating for millenia - 6-7 billion humans racing to nuclear winter without a clue - 225 ppl with as much as 2,500,000,000 ppl - 1% getting 90% of world income [& hence 90% of power to rob & kill at will - oilmen tyranny, killing millions, enslaving billions, stealing trillions]
[henry george and fred. bastiat are two examples of clearseeing, impartial economists who actually saw smthg clearly, made a real contribution - both journalists, not professional economists]
nobelprizewinning profess. economist milton friedman, famous for saying there is no free lunch - no one has noticed that bill gates av payrate of $500,000/hr & peak rate of $10,000,000/hr is a free lunch & then some - that is an indication of how far from reality we are - very very far - we think we are aware of reality - we are wrong - we are dead loudsnoring asleep - enlightenment or realisation or higher consciousness is simply waking up to reality, ie seeing clearly, ie having a better overview from higher up the hill
in fact, if everyone was being paid in proportion to work [justly], & society was not 'rubbled' with superoverpay & -underpay [pay from 1000th to 1,000,000x world av pay/hr], every family wd be getting [what they earn by their work] US$75,000/yr for working world avg hard - with which they cd be millionaires by saving a third for 40 yrs - ie, everyone is working hard enough, creating enough for everyone to be millionaires with ease - scarcity is a product of richgetricheretc, ie the endless legal drift of wealth from earners to nonearners]
capitalism + justice = peace & plenty
see my other economics answers & questions