Lecture 2a Multipliers & output models

1. Lecture 2a Multipliers & output models Regional and Local Economics (RALE) 2010 – Lecture 2a

2. RALE - Lecture 2a Last week: Introduction and profiling the local economy This week: part a) Multipliers & output models and part b) econometric models & input-output analysis Aim • To understand how all or some of the economic activity in a local economy is measured. Objective • To be able to understand the multiplier concept • To be familiar with applications of multiplier analysis, its strengths and weaknesses • To be aware of more sophisticated models of income determination Regional and Local Economics (RALE) 2010 – Lecture 2a

3. The Multiplier Concept Based on the idea that the CUMULATIVE EFFECT of an injection is greater than the INITIAL IMPACT. There are 4 Main effects when a new business starts up New Business starts up 1. Direct effect - Jobs & output from the new plant 1 2. Indirect effect - via goods & services directly purchased by the new company 2 Pays wages to staff 3. Induced effect –via the household spending locally by staff of the new plant Buys goods & services from other companies 4. Feedback loop - as companies in the supply chain to the new business and recipients of household expenditures restock and take on more staff 4 3 Regional and Local Economics (RALE) 2008 – Lecture 2a

4. Basic (Exporting) 8 Non-basic Domestic 2 Multiplier 1.25 Export base multiplier • Very simplistic early model, domestic sector assumed to service the export sector T = X + D • D = dX where d is a positive constant fraction • T = X + dX or T = (1+d)X • 1+d is the multiplier and gives a figure greater than 1 • If exports increase by 2 then T output change = 2+(0.25*2) = 2.5 • Problems – • Does not include external non-export income (wages from abroad) • Sectors are not homogeneous (Production methods are different) • Trying to define what is “export” & what is “domestic” production • Increased output can be met in a variety of ways. (>productivity) Regional and Local Economics (RALE) 2008 – Lecture 2a

5. Keynesian Income Expenditure approach Based on national income/expenditure accounting framework • Y = C + I0 + G0 + X0- M(Income, consumption and imports are regionally determined) • C = C0 + cDY (Consumption partially dependent on regional disposable income) • M = M0 + mDY (Importsdependent on regional disposable income & prop to import) • DY = Y – tY (Regional disposable income determined by the regional tax rate) • Y = k(C0+I0+G0+X0-M0) • The most important feature of the model is the marginal propensity to consume locally produced goods (c-m) • Problems – Size of region – Industry Mix - Location Regional and Local Economics (RALE) 2008 – Lecture 2a

6. The Portsmouth Naval Base directly employs in excess of 26,000 people, (70% live within 20 miles of the base). The value to the local economy is around £500million p.a. and supports 38,000 jobs overall. The additional multiplier impact is 12,000 additional jobs Multiplier process an example Output multiplier of 1.54 Source CLREA 2005 Regional and Local Economics (RALE) 2010 – Lecture 2a

7. Use of Keynesian Model – Archibald (FES) Bleaney (examined different groups mpc) Extending the basic model making allowance for transfer payments The multiplicand • Importance of 1st round leakages - may be large • Examples: Dounreay and Torness + Portsmouth NB Regional and Local Economics (RALE) 2008 – Lecture 2a

8. Applications of regional multiplier analysis • Sinclair and Sutcliff (1984) effects of tourist expenditure in Malaga (Spain). • Armstrong (1988) multipliers resulting from local economic development initiatives for different companies in local authority areas. • Work by Luger and Goldstein (1996) the forward and backward linkages of Universities. Regional and Local Economics (RALE) 2008 – Lecture 2a

9. Strengths & Weakness of Regional Multiplier Analysis Strengths • They demonstrate that injections are a process rather than an event • They identify the linkages between sectors Weaknesses • They do not take capacity constraints into account • They fail to allow for interregional feedback effects • Time is assumed discrete rather than continuous. • They provide a very aggregated picture of the impact of expenditure injections • The ability of the indigenous firms to supply inputs to expanding firms • The role of money Regional and Local Economics (RALE) 2008 – Lecture 2a

10. A simple multi-regional model of income determination • Weakness of single-region model - it does not account for interregional feedback. • One region's imports are another's exports - therefore income changes are transmitted inter-regionally. Model features • Two regions (north and south) • no supply constraints, output determined by demand for products and services. • Level of output dependant - demand own region, export demand and change in (Y) of other region). Regional and Local Economics (RALE) 2008 – Lecture 2a

11. yn A C B ys Two region model with BT function Regional and Local Economics (RALE) 2008 – Lecture 2a

12. Consequence of prolonged regional BoT Deficit • Although flows of goods and payments are not recorded, they exist and this has severe effects in the real economy. If region has a persistent BOT deficit this must be paid for by one or a combination of the following: • Net income transfer into the region by Govt. • Residents running down savings. • Borrowing from the banking system • Selling assets to residents in other regions • Long or short-term inward investment to reduce dependence on imports Regional and Local Economics (RALE) 2008 – Lecture 2a

13. World income Other regions Demand for region’s output Supply of output Regional employment More Sophisticated Models Demand-based model of income and employment Assumptions • Positive response to external shocks. • Labour supply elastic at current wage rates. • Spare capacity - output increased without increasing price • Regions are price takers (wages are set nationally) Demand for labour External Demand Regional income Weakness of the model it Ignores the fact that an increase in demand is likely to affect the price of factor inputs Regional and Local Economics (RALE) 2008 – Lecture 2a

14. World demand Regional income Demand for region’s goods Region’s employment Supply of labour Unemployment Price of region’s goods Participation rate Wage rate Competitiveness of region Net inward migration • Supply side is endogenous as demand affects the labour market and the supply of output to meet regional and world demand. • Wage rate is determined within the region as labour market tightens • Increased regional wage rates induces further supply of labour (participation and migration) • Increased regional wage rates reduce competitiveness (production costs ) Demand-based model with supply-side Regional and Local Economics (RALE) 2008 – Lecture 2a

15. Summary • Cumulative effect on a regional economy is always greater than initial injection but Impact reduces in subsequent rounds • Multiplier combination of Direct, Indirect and Induced effects, there is also a feedback loop. • Keynesian Income Expenditure model is useful for deriving overall regional multipliers. Importance of MPC – size, industry mix, location – can be extended. • Importance of 1st round injections – applications, universities, tourism, defence etc. • But there are clear weaknesses in the approach. • Multi-regional model shows the inter-connection between regions, further developments have looked at the feedback effect and the supply-side. Next econometric models & input-output analysis Regional and Local Economics (RALE) 2008 – Lecture 2a