THE MULTIPLIER ANALYSIS
Multiplier analysis explains what happens to circular flow of economic life when the behavior of one of the sectors or the components of aggregate demand - consumption, investment, government spending or net exports - changes spontaneously. Technically speaking such a behavioral change is called an autonomous shift (movements that are imposed on the system from outside) in demand. Multiplier theory also includes induced changes, the reactions that spread the effects of autonomous shifts and multiply them. If there is a drastic increase in government spending or private investment spending, the full effects of the increase on income and employment can be calculated by applying multiplier analysis. This calculation would consist of three stages. The first stage would describe the circular flow among various sectors before the increase in spending. The second would be the magnitude of change. The third would consist of the laws of behavior of the sectors of the economy and a clear picture of the pattern of flows among them. We have already discussed most of this material in the previous chapters in learning about the circular flow and connections among various sectors. This chapter will not contain many new concepts, but combine familiar information in new patterns to build multiplier analysis.
The multiplier was first incorporated into macroeconomic analysis in the 1930s when J. M. Keynes made it the cornerstone of his models of income determination in explaining the Great Depression of 1930s. Since then, the concept has been refined and quantified, so that it is now one of the most useful concepts that economists use for studying short-term changes in income and employment.
When an economist speaks of the 'multiplier', he or she may be referring to a number, a theory or analysis, or dynamics of a process. The multiplier analysis states that in a market economy any autonomous change in real planned demand for output leads to a cumulative reaction in the equilibrium level of production i.e. some multiple of the autonomous change that made it expand. The process of multiplier is nothing but the working out of this cumulative response through a definite sequence of actions and reactions among the various sectors of the circular flow. The aggregate of the cumulative reaction in output and income relative to the autonomous change in demand is the 'multiplier number'.
Here the interesting thing is that the 'multiple' is not one for one. But, it magnifies small autonomous changes in aggregate demand into larger fluctuations in output and national income or GNP. We can infer two aspects from this:
i. A general economic decline or stagnation may have a specific and localized origin even though all sectors of the economy are trouble spots. The sources of this trouble may well be in the specific problems of a single core industry. This helps in understanding economic fluctuations considerably as it helps to pinpoint the sources of instability.
ii. The second aspect is that it shows a remedy for the problem of instability and fluctuations. If the government can limit autonomous changes in aggregate demand, or neutralize them with stabilizers elsewhere in the economy, then relatively government intervention can prevent widespread instability in GNP.
These two aspects of multiplier analysis accounts for its appeal to economists and policy makers who think that government can intervene in economic activity in correcting economic fluctuation of the market economy. Further in analyzing economic change, it is essential to distinguish between those movements that are imposed on the system from outside and those that result from the general behavior of the system itself. The first of these two kinds of change is called autonomous government spending. Investment spending and exports are principal examples. The second kind is called induced. The distinction between these two kinds of change is essential for understanding the working of multiplier process.