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Economic Base Concept: Income & Employment Multipliers

(http://faculty.washington.edu/krumme/systems/multiplier.html)


Supporting  &   Related   Pages:


Income Multiplier Example - [Click for the graphic version of this example!]

pcl = .8(Propensity to consume locally)
icles = .25(Income created by local consumption sales (per $ of sales)

(a)Income (Use)Y=C + SIncome use in a closed economy without government
(b)Y=Cl + Cnl + SLocal & non-local consumption





(1) Income (Origins)Y=Yb + Yn"Basic" and "Non-basic" Income
(2) Local ConsumptionCl= .8 Y
(3) Local IncomeYn=.25 Cl





(4) Yn=.25 x .8 Y
(5) Y=Yb + .2 Y
(6) Yb=Y - .2 Y
(7) Yb=Y (1 - .2)
(8) Y=...Yb
( 1
--------
1 - .2
)
(9) Y = Yb x 1.25

Multiplier=1
---------------
1 - .8 x .25
=1
-----
.8
= 1.25

A Simplified graphic Model


Employment Multiplier:

Definitions:

  • "The employment multiplier associated with a particular regional economic stimulus is designed to yield an estimate of the total employment attributable to the stimulus per job or man-year of employment directly created." [Davis, Regional Economic Impact Analysis and Project Evaluation, 1990, p.37]
  • The (basic/non-basic) employment "multiplier is equal to total (or increase in) employment in both basic and service activities divided by total (or increase in) basic employment." [Isard, Methods of Regional Analysis, 1960, p.190]


    (1) T = B + N




    (2) B = T - N




    (3) B
    ---
    T
    = T - N
    --------
    ....T




    (4) B
    ---
    T
    = 1 - N/T




    (5) B = T (1 - N/T)




    (6)T =.. B
    (1
    ---------
    1 - N/T
    )
    ^
    |
    |
    MULTIPLIER

    simplified further:
    M = T
    ---
    B

    (7) Tt+1 = Bt+1
    (Tt
    ----
    Bt
    )
    (Application to forecasting
    next year's total employment)

    A systematic overview of the different formulations of the basic/nonbasic multiplier can be found here.


    Where: T = Total Employment
    B = Basic Employment
    N = Nonbasic Employment

We need to differentiate between the Multiplier (M) itself and the Multiplier Effect. The multiplier is simply a ratio (i.e. NOT an absolute number), whereas the multiplier effect refers to the number of jobs (or the amount of income) supported or created by the basic jobs (or income). Thus, to identify the multiplier effect from above equations, we need to multiply the basic jobs (income) by the multiplier and then deduct the basic employment (or income), since the "effect" should not include the "stimulus".


The Location Quotient & the Multiplier

The location quotient (l.q.) is frequently used to estimate the economic base of a region. How will we do that? If the l.q. for a sector exceeds one, the sector is presumed to export. Thus, we take all sectors with an l.q. of above one and determine, sector by sector: (and then sum the export employment for all these sectorsi)

Local Service Employment
in sectori
= Total Employment in sectori
-------------------------
l.q.
Export employment
for sectori
= Total Employment
in sectori
( 1 - 1
----
l.q.i
)

Caveats or Possibly Needed Adjustments:
Note that adjustments to these calculations tend to be made since some of the underlying assumptions are not always realistic:

  1. The benchmark region (nation) has no exports in sectori The existance of national exports would lead to understating a region's basic employment, since benchmark consumption would actually be less than assumed.

  2. Identical consumption patterns or tastes (aggregate regional consumption functions, consumption baskets) Regions with higher local consumption of industryi's product would need more employment to satisfy local demand; thus the l.q. method would overestimate export employment

  3. Identical production functions, between region and nation specifically (or implying)

    1. identical labor productivities, Regions with productivities higher than the nation would need less labor to satisfy local demand; thus, the l.q.method would underestimate export employment.

    2. identical output mix Different types of production aggregated to regional or national totals under the same industry labels would be expected to be based on different production functions and productivities. Thus, location quotients might have to be adjusted to take account of these different product mixes.

  4. No "cross-hauling": To the extent that a regional sector's outputs are both exported and at the same time imported from other regions, the location quotient approach would underestimate export (basic) activites (and therefore would have to be adjusted)


For more on such adjustments, see:

  1. H. Craig Davis, Regional Economic Impact Analysis and Project Evaluation, 1993, pp.16-18.
  2. Richard E. Klosterman, Community Analysis and Planning Techniques, 1990, pp.134ff.
  3. William Schaffer, Regional Impact Models, Location Quotient Method "The literature records at least three specific assumptions: (1) that local and benchmark consumption patterns are the same, (2) that labor productivity is a constant across regions, and (3) that all local demands are met by local production whenever possible. The first assumption is not serious: not only can we not discern differences in consumption patterns without extraordinary expense but we can suspect that differences in production patterns are more important. Purchases of intermediate goods by producers differ for regions depending on industry mix."


Internet Sites: 


Literature:

Davis, H.C., Regional Economic Impact Analysis and Project Evaluation, 1990, Ch.2 (Economic Base Analysis, pp.9ff.)

Isard, Walter. Methods of Regional Analysis, 1960, pp.189ff. ("Regional Multipliers: The Economic Base Type")

Malecki, Edward J., Technology and Economic Development. 2nd ed., 1997, pp.15ff. ("The economic base and regional multipliers")

Schaffer, W. Chapter 2: REGIONAL MODELS OF INCOME DETERMINATION: SIMPLE ECONOMIC-BASE THEORY (Regional Impact Models, Online, 1999)


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