Pretend you are a member of the Council of Economic Advisors and you are trying to persuade the members of the House Appropriations Committee to spend $100 billion in new highway construction and repairs, in part to stimulate the economy. The members of the Committee are not familiar with the multiplier process and have asked you to explain. Please explain to the members how the multiplier process will work.

 

How the multiplier works process works

A multiplier broadly refers to an economic factor that, when increased or changed, causes increases or changes in many other related economic variables. In terms of gross domestic product, the multiplier effect causes gains in total output to be greater than the change in spending that caused it thus the multiplier process is aimed at improving the economy by injecting $100 billion into the economy so as to cause more gains than the money actually spent in the investment which for our case is highway construction and repair.

Since this is an investment ,it will therefore take the form of investment multiplier which implies that any increase in public or private investment spending has a more than proportionate positive impact on aggregate income and the general economy.

I would explain to the committee that the larger an investments multiplier is, the the more efficient it is in creating and distributing wealth throughout the economy thus stimulating economic growth. Thus spending the $100 billion to construct the new highway will increase the income of construction works, as well as the income of materials suppliers. These people may spend the extra income in the retail, consumer goods, or service industries, boosting the income of the workers in those sectors of the economy thus improving economic growth, this will also increase money flow in the economy as the money change hands between consumers and producers.

Since this is a large investment, the marginal propensity to consume of the project is higher than that of the workers so they spend a greater percentage of their income on other parts of the economy, thereby spreading the economic stimulus caused by the initial investment more widely to the whole economy as a whole, this improves economic growth and development.

If for example if the marginal propensity to consume by the construction workers is 0.8,then they save the remaining 0.2,using the multiplier formulae therefore;

multiplier=1/(1-MPC)

1/(1-0.8)

=5

this means that for every $1 dollar earned from the $100 billion generates additional income of $5 so that would mean that the $100billion would multiply 5 times while in the economy, that is $100billionx5=$500. From the example it is clear that investing on the highway and repairs will favor the growth and development of the economy and thus it is wise to carry on with the investment to stimulate the economy.