Macroeconomics and Tourism
Lecture 6

 

The Keynesian Multiplier Effect

1. Keynesian Multiplier Effect - the impact on the economy (or GDP) when spending or investment changes in the economy

  • Example - Hilton builds a new resort-hotel on Langkawi
    • Direct Effect - Hilton invested $50 million in building the facility
      • Hilton hires 200 workers
      • Construction hires 500 workers (temporary)
    • Indirect Effect - with more income, the employees and construction workers spend more
      • New houses
      • New cars
      • Clothing, restaurants, cinemas, etc.
    • Induced Effect - local businesses have more customers and earn more profits and income
      • These businesses hire more workers
      • Workers work longer
      • These employees have higher income and increase their spending and savings
    • The process continues indefinitely
  • The $50 million investment in Langkawi could result in more than $50 million in incomes
  • Other benefits
    • More local labor is hired
    • More income generates more government's tax revenue
    • Government can increase its spending and provide more services to the community
  • The more money changes hands, the higher the income
  • Note - a tourist who bring foreign currency, will have the same impact

2. The multipler effect can also apply to a contraction

  • Economists do not focus on this
  • Example - a large firm or plant shuts down
    • Workers are laid off
    • They have less income and decrease their spending and savings
    • Other businesses experience a slow down
    • They reduce their workforce
  • The process continues indefinitely
  • Note
    • Less income means government collects less tax revenue
    • Usually government increases or expands taxes
  • Example
    • Flint, MI - GM shut down its factories
    • Gary, IN - U.S. steel industry severely contracted with competition from Japan during 1980s
    • Problems
      • Jobs left, then the workers with money left
      • The poor were left behind, and crime and drugs became rampant

3. The ratio method to derive the multiplier

  • What drives the multiplier?
    • Investment
    • Changes in government spending,and taxes
    • Changes in net exports
    • Tourists' spending
  • Example: Investment increases by $100
    • MPC = 0.9 and MPS = 0.1
    • Round 1: Income increases by $100;    Savings is $10 and consumption is $90
    • Round 2: Income increases by $90      Savings is $9 and consumption is $81
    • Round 3: Income increases by $81      Savings is $8.10 and consumption is $72.90

 

    • Infinity     Total savings is $100 and total consumption is $1,000
      • This is an infinite sequence

The equation for the multiplier effect

  • For our example, GDP changes by

An example of the muultiplier effect

  • Note - Savers deposit their money into banks
    • The banks grant loans to businesses for new investment
    • If people hide their money in a mattress, then banks do not have money to lend out for new investment
    • Banks and investment go hand in hand with economic development
  • We can also calculate the multiplier in two ways
    • First way we know MPS (or MPC), then the multiplier is:

Calculating the multiplier for an example

    • Second, if we knew how GDP changed when investment changed, then we use algebra to rearrange the equation to get:

Calculating the effect of a multiplier on an economy

 

Deriving the Multiplier

1. Definitions

  • Disposable Income (DI) - remaining income after taxes are deducted
    • Disposable income is either spent on consumption or saved
  • Marginal Propensity to Consume (MPC) - the amount a society increases its consumption, if its aggregate disposable income increases by $1
  • Marginal is important!
    • Example, a low-income country has a GDP per capita of $5,000 per year
      • People may have low savings rate
      • People may have high consumption rate, because of food
      • Banking system may not develop well with low savings rate
    • Example, a high-income country like Qatar has a GDP per capita of $80,000 per year
      • People have high savings rates
      • Qatar can invest its money in developed countries like Europe and United States
    • Savings and consumption can be different for different levels of disposable income
  • MPC is the slope of the consumption function, C = f(DI)

Equation for marginal propensity to consume

  • Marginal Propensity to Save (MPS) - the amount a society increases its savings, if its aggregate disposable income increases by $1
  • MPS is the slope of the savings function, S = g(DI)

Equation for marginal propensity to save

  • By definition, MPS + MPC = 1, because if disposable income increases, a society either spends it or saves it.
  • As disposable income increases, both the consumption and savings increase
  • Both C = f(DI), and S = g(dI) have positive slopes

2. Factors shift the consumption and savings functions

  1. Wealth - households' level of wealth determines consumption and savings
    • As households become wealthier, their consumption may increase
      • physical - houses, cars, real estate, and land
      • financial - cash, stocks, bonds, pensions, etc.
    • Example - Financial crisis of 2008
      • Stock prices and home values are dropping, people become less wealthy and may decrease their consumption
      • Both consumption and savings functions decrease and shift downward.
  2. Expectations - households expectations of the future determine consumption and savings levels
    • Example - A person graduated from college and found a high-paying job, his consumption and savings will both increase
    • 2008 Financial Crisis
      • With an uncertain financial future, households will save more
      • Consumption function could decrease and savings function could increase
  3. Real Interest Rates - impact household consumption and savings
    • If real interest rates are low, households decrease their savings, and increase their consumption
  4. Household Debt - households can borrow from future income
    • Households can consume more today by borrowing and increasing their debt
    • Consumption increases, while savings functions both could decrease
  5. Taxes
    • If government increases taxes, disposable income decreases
    • Households have to lower their consumption and/or savings
    • Consumption and savings functions both could decrease

3. Aggregate Expenditures (AE) - the total spending by all sectors in an economy

  1. Consumption
    • Autonomous Spending (A) - the y-intercept
      • Spending is independent of income (i.e. GDP)
      • Consumers still need a level of spending with no income
        • Food
        • Shelter, etc.
    • MPC - the slope of the line
      • Give consumers $1 more dollar in income, MPC is the amount that goes to spending

Equation for the consumption function

    • A graph of the consumption is below:

A graph of the consumption function

  1. Gross investment (Ig) - all investment in society
    • assume investment is independent of GDP and Aggregate Expenditures

A graph of the investment function

  • Net exports (Xn) = Exports (X) - Imports (M)
    • If Xn > 0, country exports more than what it imports
      • Expands domestic production
      • Has multiplier effect
    • If Xn < 0, country imports more that what it exports
      • Expands production for foreign country
      • Negative multiplier effect
      • The foreign country gets the multiplier effect
    • Shifting level of net exports
      • Prosperity abroad
      • Tariffs
      • Exchange Rates
  • Government spending (G)
    • Independent of GDP
    • Government finances spending through taxes
      • Lump sum taxes - taxes are assessed as a fixed dollar amount

4. Equilibrium

  • Equilibrium is when, Aggregate Expenditures (AE) = GDP
    • AE is one definition of GDP
    • This is the 450line
  • Leakages- withdrawals from income / expenditure stream
    • Savings
    • Taxes
    • Imports
  • Injections - income is injected into income / expenditure stream
    • Investment
    • Government spending
    • Exports
  • Equilibrium
    • AE = GDP and AE = C + Ig + G +Xn
    • Leakages = Injections
      • S + T + M = Ig + G + X

Aggregate Expenditures and the equilibrium condition

5. Derive the multiplier by substituting the consumption function and equilibrium condition into the AE. Then use algebra to solve for the equilibrium GDP.

Deriving the multiplier

  • Consequently, the multiplier = 1 / MPS

6. Equilibrium is stable

Stability of the aggregate expenditure function

  • At GDP1, Aggregate Expenditures exceeds GDP
    • Businesses and consumers are spending more than the amount of goods and services produced in the economy
    • Inventories are falling
    • Businesses increase their production of goods and services
  • At GDP2, GDP exceeds Aggregate Expenditures
    • Businesses and consumers are spending less than the amount of businesses are producing
    • Inventories are increasing
    • Businesses decrease their production of goods and services
  • When GDP = AE, economy is in equilibrium
    • Total leakages = Total injections
    • No unexpected changes in business inventories

Incorporaing Tourism into Aggregate Expenditures

1. Starting with the relationship, GDP = AE = C + Ig + G + Xn

  • Tourism can lead to higher GDP
    1. Consumption - tourists buy goods and services
    2. Balance of Payments, Xn = Exports (X) - Imports (M)
      • Tourists are invisible exports
      • Tourist bring foreign currencies
      • Tourist buy local goods and services
    3. Investment - private companies invest in tourist infrastructure
    4. Government Spending - improve infrastructure in a region
      • Roads
      • Airport
      • Ports

2. Problems of tourism

  1. Inflation
    • Tourism creates higher demand for land, property, and goods / services
    • International tourists will pay higher prices than domestic tourists
    • Price increases are usually permanent
    • Local population, especially ones not involved in tourism pay higher prices
  2. Opportunity costs
    • If government invests in a tourist facility, program, or service, then the funding cannot be used for something else
    • Use cost-benefits analysis to determine if efficient
  3. Dependency - reliance on a single industry
    • A decrease in tourists can have negative impacts on a country, if country overrelied on tourists
    • Use formula

A country's dependence on tourism

    • Example - Malaysia had approximately 22.4 million tourists in 2010
    • 13.0 million tourists were from Singapore
    • The dependency ratio is 58%
    • Malaysia could have problems, if Malaysia falls out of favor from Singaporeans
  1. Tourist destinations are sensitive to changes in demand
    • Wars, terrorism, and natural disasters scare tourists away
    • Examples
      • 2011 Riots in Egypt
      • SARS outbreak in China
      • Tsunami disaster in Thailand
  2. Economic development from tourism is unequal
    • Tourist destinations developed economically
    • Surrounding areas may not develop
  3. Seasonality
    • A tourist destination may have one or two peak seasons
    • Examples - Turkey, Greece, Eygpt, Spain, and Thailand
    • High season - opportunity to earn large profits
    • Low season - more difficult to earn profits
      • Workers idle for part of the year
      • Some facilities like hotels shut down for part of the year
      • Difficult to recoup investment
  4. Leakages
    • Tourist industry may import some goods and services for tourists
    • Tourist industry may hire foreign workers
    • Tax revenue flows out of tourist region
    • Workers in tourist industry may be high savers
    • Foreign owned hotels and businesses send their profits out of a country

 

The Multiplier Effect for Tourism

1. Multiplier Effect for Tourism

  • Direct effects - tourism spend money on transportation, hotels, restaurants, etc
  • Indirect effects - generated from economic activity of subsequent expenditure
    • Hotels and restaurants purchase supplies and use local services
  • Induced effects - arising from spending of income occurring to local residents from tourism wages and profits
    • Investment activity: arising from capital investment in new facilities for visitors
    • Government: public sector funding

2. Derivation of the tourism multiplier

  • Start with the equations,
    • AE = C + G + Ig + X - M
    • C = A + (MPC)(GDP)
    • AE = GDP
    • M = (m)(GDP)
      • m is the portion of GDP that is imported
      • Also called the marginal propensity to import
      • Could be high for importing countries
  • Assume - supply is elastic (or perfectly elastic); suppliers can meet the increase in demand

Deriving the tourism multiplier

3. Income multipliers for several countries

  • Small island countries have small multipliers
  • Economy is small with high leakage
Country Income Multiplier
Ireland 1.776 - 1.906
United Kingdom 1.683 - 1.784
Dominica 1.195
Bermuda 1.099
East Caribean 1.073
Bahamas 0.782
Cayman Islands 0.650

Source: Horwath Tourism & Lesisure Consulting. November 1981. Tourism Multiplier Explained.

4. Different types of multipliers

  1. Sales Multiplier - the extra business turnover generated by an additional unit of tourist spending
  2. Income Multiplier - the extra income generated from an additional unit of tourist spending
    • Could be defined as disposable income
    • Could Include the increase in tax revenue
  3. Employment Multiplier - the extra employment created from an additional unit of tourist spending
Country Sales Multiplier
Turkey 2.339 - 3.198
Barbados 1.41
Gwynedd, North Wales 1.16

Source: Horwath Tourism & Lesisure Consulting. November 1981. Tourism Multiplier Explained.

Tools for Estimating Tourism Impact

1. Input-Output Model - represent interdependencies among industries in an economy

  • Wassily Leontief
  • Very simple
  • Requires high quality data
  • Cannot handle changes in relative prices
  • Capital and labor are used in fixed ratios
    • One worker for every machine
    • Standard production function - ratio of capital and labor can be varied
  • No excess surplus of production; all products and services are consumed
  Outputs
Input Agriculture Manufacturing Services Tourism Exports Total Outputs
Agriculture 20 40 50 5 20 135
Manufacturing 60 20 10 10 10 110
Services 20 30 80 15 15 160
Tourism 0 0 20 5 15 40
Imports 35 20 0 5 0 60
Total Inputs 135 110 160 40 60 505
  • Example
    • Inputs to the tourism industry. Tourism uses 5 (billion) from agriculture, 10 (billion) from manufacturing, 15 (billion) from services, 5 (billion) from tourism industry, and 5 (billion) from imports.
  • Total inputs = $40 (billion), which has to equal total outputs
    • Notice, exports = imports
    • Outputs to the tourism industry. Tourism has zero output to agriculture and manufacturing industries. However, services takes $20 (billion) in services, $5 (billion) in tourism, and $15 (billion) for exports.
      • Imports for tourism is a leakage
  • Total GDP should be the summation of all industries, $505 (billion)
    • Tourism is 7.9% of economy

2. Cost-Benefit Analysis

  • Applies to new investment projects
  • List all the costs and benefits of project
  • Typical time span is 10 years or longer
  • Problems
    • Example - government has cost-benefits analysis to develop new beach
    • Estimate tourists
    • Private investment
    • Jobs created, etc.

 

Terminology

  • Keynesian multiplier effect
  • direct effect
  • indirect effect
  • induced effect
  • disposable income (DI)
  • marginal propensity to consume (MPC)
  • marginal propensity to save (MPS)
  • aggregate expenditures (AE)
  • autonomous spending (A)
  • gross investment (Ig)
  • net exports (Xn)
  • government spending (G)
  • lump sum taxes
  • leakages
  • injections
  • dependency
  • sales multiplier
  • income multiplier
  • employment multiplier
  • input-output model
  • cost-benefit analysis
 

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