Top 3 Types of Multiplier in Economics

Here we detail about the top three types of multipliers in economics.

(a) Employment Multiplier:

Employment multiplier is associated with the name of Prof. R.F. Kahn. The idea of multiplier had its origin in 1931 when Prof. Kahn was discussing the favourable effects of public investment on aggregate employment.

Prof. Kahn was of the view that an initial increase in employment leads to a very large increase in the total employment. All discussions on public works prove that besides the ‘original’ or ‘primary’ employment in the public works, there will be ‘secondary’ employment, resulting from public works. Secondary employment is that which occurs in consumption goods industries as a result of the primary employment in public works.

Kahn’s employment multiplier is a ratio of a change in total employment to the primary employment. Primary employment stands for the employment of the workers in public works like drainage, digging, roads, buildings, etc. As the workers are employed, they get income which increases aggregate demand and it leads to expansion of output in consumer goods industries, which in turn, leads to more employment, more demand for goods and machines and so on.

The prosperity and development of the industrial sector leads an expansion of tertiary activities like banking, insurance, trade, transport etc. Suppose 2 million persons are employed in the construction of roads, they demand more consumer goods, thereby raising the demand in consumer goods industries; this will lead to additional employment in such industries.

Additional income will flow to the additional workers employed in consumer goods industries who again demand more goods and services thereby giving a fillip to secondary employment of six million workers and raising the total employment to 8 million workers giving us the employment multiplier equal to 4, being the ratio of the total increase in employment to the initial increase in employment (i.e.,⁸/₂ = 4).

Kahn’s employment multiplier is shown by the letter K’ to distinguish it from Keynes’ investment multiplier expressed by K. If N₁ is the primary increase in employment and N₂ the total increase in employment, then employment multiplier (K) is equal to N₂/N₁ or K’- N₂N₁ or KN₁ = N₂.

The expression ∆N₂ = K’. ∆N₁ is similar to the expression ∆Y = K ∆I. According to Prof. Hansen, we do no great violence to the facts if we take employment multiplier (K) equal to investment multiplier (K), though we have no reason to presume them to be equal to each other. For the sake of simplicity and understanding, we take them to be the same for all practical purposes, at least in the short period, because when the investment increases, employment also increases though not in the same ratio.

(b) Price Multiplier:

Investment or income multiplier operates only so far as full employment is not reached. In other words, it has a full employment ceiling. When the full employment ceiling in an economy is reached, the scarcities of factors, goods and services start appearing: as such, after the full employment, the multiplier starts working in relation to prices only and is rightly described as the ‘price multiplier’.

When ‘inflationary shook’ is introduced by a constant stream of an autonomous real investment, (fixed amount regardless of price increases, such as associated with war expenditure, deficit spending etc.), it will increase the level of money national income via the multiplier action. A small injection to the money income stream of the economy increases it (income) by many times. Price multiplier, therefore, refers to the ratio of the ultimate increase in the general price level to the initial increase in prices (on account of the increased money supply).

It implies that the initial price (as a result of taxation or increase in money supply or any other reason) is not limited to that extent only but other prices also rise in sympathy with the rise in basic prices leading to a general or multiple increase in the price level. This is what happened in India as a result of the taxation policy followed during emergency after the Chinese aggression in October 1962 and Indo-Pak wars of 1965 and 1971. That part of the defence expenditure which was spent within the country proved to be highly inflationary.

Similarly, in developing economies (striving hard to develop fast) certain maladjustments in the forces of demand and supply often appear, resulting in the inelastic supplies of some strategic and basic commodities (including factors of production and services). A small addition to the money income stream (whether through tax financed expenditure, deficit financing, mobilisation of past hoardings like gold or black money) increases the general price level by a multiple of what was initially warranted by the increased money supply.

Price multiplier may be a necessary explanation of general price increases in an economy but is not a sufficient explanation of the behaviour of general prices. In advanced economies, price multiplier manifests itself only after the full employment level has been attained because the factors of production start becoming scarce.

Its operational significance lies in that it constitutes an important leakage from the income stream of an economy and reduces the value of the income multiplier, so that after full employment level, the multiplier works in relation to prices only and shows how important it is to curb the initial rise in the price level lest it should eat into the vitals of the economy.

Same is the position in underdeveloped economies where the working of the income (investment) multiplier gets impaired on account of various reasons (specially various leakages). In such economies price multiplier starts working earlier and limits the magnitude of income multiplier. This is what we mean when we say that the underdeveloped economies are highly inflation-sensitive, where price multiplier seems to precede the income multiplier as it happens to work with reference to money income only and not with reference to real income and employment.

(c) Consumption Multiplier:

Consumption multiplier as enunciated by Dr. P.R. Brahmanand and Prof. C.N. Vakil, is based on the concept of ‘saving potential’ developed by Prof. R. Nurkse in his famous book ‘Capital Formation in Underdeveloped Countries’. It is their belief that if we really want to break the vicious circle of poverty and generate a process of economic development it is essential to make use of the saving potential, of the subsistence and un-organised sector in the economy.

According to them, there is 25 to 30% disguised unemployment in the rural sector of underdeveloped economies. The ‘disguised unemployment’ constitutes the ‘saving potential’. Thus, we can always remove from the land certain unproductive workers, who seem to be apparently employed but who in fact are not actually employed, i.e., their removal will not lead to a decline in the production.

We can remove those workers who do not add anything to production, if somehow we are able to provide basic consumption goods to the batch of workers which is initially removed from the land; this will, in turn, lead to greater increase in aggregate investment and-employment (consumption multiplier). The idea underlying the consumption multiplier is that with an initial increase in the supply of consumption goods (wage goods), there will be multiple increase in the ultimate investment.

In other words, it is the ratio of the ultimate increase in the aggregate investment to an initial increase in the supply of consumption goods. Put in simple words, it implies that if we are able to manage some marketable surplus for the initial batch of workers, then the investment and employment can be increased manifold.

Let us suppose that the production of wage goods rises by 1000 units. The real wage (w) is one unit and the average consumption of the disguised unemployed (d) is ½ unit. Therefore, the average difference between w and d is ½ unit. Let us call this difference as the gap (½). Let us suppose, further, that the above 1000 units are used by the state for investment purposes.

The question (to be decided by the consumption multiplier) is how much increase will take place in total investment and employment as a result of the initial expenditure of 1000 units and initial employment of 1000 workers ? It is clear that the increase in the production of 1000 consumer goods will enable the transfer of 1000 disguised unemployed and convert them into productive workers. This will, in turn, give a surplus of 500 consumption units (d – ½) and enable further a transfer of 500 workers.

The transfer of 500 workers would release 250 consumption units (d = ½) and enable a transfer (employment) of 250 workers and so on. Thus, we find that the initial investment of 1000 consumption units and employment of 1000 workers lead to an additional employment of 1000 workers, thereby raising the total employment of 2000 workers giving us the consumption multiplier 2 (2000/1000 = 2). Thus, it is quite clear that whenever there is an increase in the wage goods, other things remaining the same, it is possible to expand investment and employment by a greater proportion to the initial increase in wage goods and employment. In other words, an initial increase in the marketable surplus enables us to increase employment in investment more than proportionately to the marketable surplus.

The basic difference between the Keynesian multiplier and the consumption multiplier is that the former indicates by how much the total income would go up as a result of initial increase in investment whereas the latter tells us how much investment will go up as. a result of a given increase in the supply of wage goods…the consumption multiplier tells us by how much the consumption of wage goods in the economy will have to go down, if a given increase in investment has to be self- financing, whereas the Keynesian multiplier tells us by how much savings will have to go up if a given increase in investment has to be self-financing.”

The consumption multiplier, however, like any other multiplier, works under certain limitations and assumptions, such as: the marginal propensity to consume wage goods on the part of the wage goods sector, that the price level and the real wage rates do not change, that the average consumption of the disguised unemployed worker is less than the productively employed worker (i.e., d < w), that the size of the population does not change, etc..