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Home  Field Trips Wildlife Tour Multiplier PrincipleTheoriesThe Multiplier PrincipleBack to field trips home page >> Any injection into the circular flow of income of a country will start a multiplier effect. As the tourist industry grows there will be a number of injections. Increases in the number of foreign tourists using Zambian hotels, national parks and other facilities will represent an increase in exports. In addition the investment needed to provide the tourist facilities will also be an injection. How do these initial injections bring about the multiplier effect? Increasing spending on tourist services by foreign citizens provides incomes to the factors of production employed in the tourist industry which itself would eventually get spent. One person's spending became someone else's income, which is then in turn, spent. An initial injection of spending would generate a whole series of rounds of additional spending and income generation. Every time extra spending occurs it may mean that more people will be employed. Thus the spending by tourists could have a much greater effect that simply the amount that they spend themselves. If governments spend an extra $10m on building hotels the incomes of factors of production involved in the building industry increases by $10m. Some of this increase in income will be spent on local consumer goods. The increase in consumption arising out of a change in income is called the marginal propensity to consume (MPC). It is defined as the proportion of each extra unit of income that is spent. Of course this extra income will generate extra leakages. The amount of any change in income that is leaked out of the circular flow of income is called the marginal rate of leakage. This will be made up from the marginal propensity to save (MPS), the marginal rate of taxation (MRT) and the marginal propensity to import (MPM) Let us suppose that in our example when the income of the hotel builders increases by $10m that $6m is spent on consumption. The marginal propensity to consume can be calculated using the following formula.
60% of every dollar earned is spent on consumer goods. The other 40% leaks out of the circular flow of income in the form of savings, taxation and imports. The amount can be calculated using the following formula.
Let us suppose that MPS =0.2, MRT= 0.1 and MPM=0.1. It should be apparent that if we add the MPC, MPS, MRT and MPM the result will be 1. They are, after all, proportions of a whole. It should be remembered that the propensities are usually expressed as a decimal. 
It is possible to use a formula to allow us to calculate the size of the multiplier process. From this it is thus possible to calculate the size of the change of national income following a change in the level of export spending. DNY = DX x K K = the multiplier coefficient ( the amount any change in income induced spending is multiplier by to arrive at the resultant change in national income)
Alternatively
In our example
Alternatively
Continuing with the calculation
Thus the increase in export spending of $100 has led to a larger increase in national income of $250. This is called the multiplier effect. It has arisen because of the extra consumer spending that has been generated out of any change in income being passed on to generate more income to other factors of production. The size of the multiplier will depend upon the size of the MPC and thus the size of the marginal rate of leakage (MPS, MRT and MPM). Back to field trips home page >>
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