Lecture 2a - The Economics Network

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Local & Regional Economics
Lecture 2a Multipliers & output models
Regional and Local Economics (RALE) 2010
– Lecture 2a
1
Local & Regional Economics
RALE - Lecture 2a
Last week: Introduction and profiling the local economy
This week: part a) Multipliers & output models
and part b) econometric models & input-output analysis
Aim

To understand how all or some of the economic activity in
a local economy is measured.
Objective

To be able to understand the multiplier concept

To be familiar with applications of multiplier analysis, its
strengths and weaknesses

To be aware of more sophisticated models of income
determination
Regional and Local Economics (RALE) 2010
– Lecture 2a
2
Local & Regional Economics
The Multiplier Concept Based on the idea that the
CUMULATIVE EFFECT of an injection is greater than
the INITIAL IMPACT. There are 4 Main effects
when a new business starts up
New
Business
starts up
1. Direct effect - Jobs &
output from the new plant
2. Indirect effect - via goods &
2
services directly purchased
by the new company
3. Induced effect –via the
household spending
Buys goods &
locally by staff of the new
services from
plant
other
4. Feedback loop - as
companies
companies in the supply chain
4
to the new business and
recipients of household
Regional
expenditures restock and
take and Local Economics (RALE) 2008
– Lecture 2a
on more staff
1
Pays wages
to staff
3
3
Local & Regional Economics
Export base multiplier
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Very simplistic early model, domestic sector assumed to service the export sector
T=X+D
D = dX where d is a positive constant fraction
T = X + dX or T = (1+d)X
1+d is the multiplier and gives a figure greater than 1
If exports increase by 2 then T output change = 2+(0.25*2) = 2.5
Basic
(Exporting) 8
Non-basic
Multiplier
1.25
Domestic 2
Problems –
Does not include external non-export income (wages from abroad)
Sectors are not homogeneous (Production methods are different)
Trying to define what is “export” & what is “domestic” production
Increased output can be met in a variety of ways. (>productivity)
Regional and Local Economics (RALE) 2008
– Lecture 2a
4
Local & Regional Economics
Keynesian Income Expenditure approach
Based on national income/expenditure accounting framework
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

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Y = C + I0 + G0 + X0- M (Income, consumption and imports are regionally determined)
C = C0 + cDY
(Consumption partially dependent on regional disposable income)
M = M0 + mDY (Imports dependent on regional disposable income & prop to import)
DY = Y – tY
(Regional disposable income determined by the regional tax rate)
Y = k(C0+I0+G0+X0-M0)
See Armstrong and Taylor (2000) pp 8- 15
k
1
1  1  t c  m 
The most important feature of the model is the
marginal propensity to consume locally produced
goods (c-m)
Problems – Size of region – Industry Mix - Location
Regional and Local Economics (RALE) 2008
– Lecture 2a
5
Local & Regional Economics
Multiplier process an example
Naval Base and
Operational Staff
6,100 jobs
1. The Portsmouth Naval
Base directly employs
Maritime Defence Outer Core
Other Training
MoD Support
in excess of 26,000
Bases inc. Flagship
Agencies
people, (70% live
6,850 jobs
2,350 jobs
within 20 miles of the
A+B+C
A+B+C
base).
Maritime Defence Inner Core
B+C
Base Heritage Area
250 jobs + 335,000
visitors
Base Prime & Day
Contractors
3,550 jobs
A+B+C
A+B+C
Portsmouth Based
Ships 7,300 crew
B+C
Visiting Warships
18,500 crew
B
Local Expenditures
net of Tax & NI
£437.1m
Output
multiplier of
1.54
£326m - Expenditure into local economy
Leakages
Mainly household purchases
out of the local area +
expenditure taxes
£110.5m
A
Purchases from local
defence industrial base
& other suppliers
£70.0m
B
C
Visitor & tourist spending
in the local economy
£40.9m
Wages spent as household
purchases in the local area
£215.7m
2. The value to the local
economy is around
£500million p.a. and
supports 38,000 jobs
overall.
3. The additional
multiplier impact is
12,000 additional jobs
+ £178m Multiplier effect from Local Economy Forecasting Model
Source CLREA 2005
Regional and Local Economics (RALE) 2010
– Lecture 2a
6
Local & Regional Economics
Use of Keynesian Model – Archibald (FES) Bleaney
(examined different groups mpc)
Extending the basic model making allowance for transfer
payments
Y
1
C  I G  X  M
1   1  t   c  m  g
0
0
0
0
In itial in jectio n
in cr easin g exp en d itu r e
in to th e r eg io n
0
Government
Subsidies on
additional
Expenditure
The multiplicand
 Importance of 1st round
leakages - may be large
 Examples: Dounreay and
Torness + Portsmouth NB
Increase in gross regional
product (GRP): Wages, salaries,
profits, rent, interest & dividends
inco
co
ear
un
(from
Indirect & induced
expenditure in the
region
Adapted from Armstrong and Taylor (2000) pp 14
Regional and Local Economics (RALE) 2008
– Lecture 2a
Increase in regional
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disposable income (RDI)
Local & Regional Economics
Applications of regional multiplier analysis
 Sinclair and Sutcliff
(1984) effects of tourist
expenditure in Malaga
(Spain).
 Armstrong (1988)
multipliers resulting from
local economic
development initiatives
for different companies in
local authority areas.
 Work by Luger and
Goldstein (1996) the
forward and backward
linkages of Universities.
University
Inputs backward linkages (short-ru
Local business
Demandforservices
Displacement effects
Local G
overnment
Services &revenues
Improvedrevenue base
Additional demand
Congestionproblems
Outputs forward linkages (long-run effects
Adapted from Armstrong and Taylor (2000) pp 19
Regional and Local Economics (RALE) 2008
– Lecture 2a
Humancapital
8
Local & Regional Economics
Strengths & Weakness of Regional Multiplier Analysis
Strengths
 They demonstrate that injections are a process rather than an
event
 They identify the linkages between sectors
Weaknesses
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They do not take capacity constraints into account
They fail to allow for interregional feedback effects
Time is assumed discrete rather than continuous.
They provide a very aggregated picture of the impact of
expenditure injections
 The ability of the indigenous firms to supply inputs to
expanding firms
 The role of money
Regional and Local Economics (RALE) 2008
– Lecture 2a
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Local & Regional Economics
A simple multi-regional model of income
determination
 Weakness of single-region model - it does not account for
interregional feedback.
 One region's imports are another's exports - therefore
income changes are transmitted inter-regionally.
Model features
 Two regions (north and south)
 no supply constraints, output determined by demand for
products and services.
 Level of output dependant - demand own region, export
demand and change in (Y) of other region).
y    y y    y
n
s
s
Regional and Local Economics (RALE) 2008
– Lecture 2a
n
10
Local & Regional Economics
Two region model with BT function
y    y
yn
s
y
*
n
BT  0
n
y    y
n
y
a
A
s
y
n
C
y

B
s

y

s
y

*
s
n
y
n
ys
Regional and Local Economics (RALE) 2008
– Lecture 2a
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Local & Regional Economics
Consequence of prolonged regional BoT
Deficit
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Although flows of goods and payments are not recorded,
they exist and this has severe effects in the real
economy.
If region has a persistent BOT deficit this must be paid
for by one or a combination of the following:
Net income transfer into the region by Govt.
Residents running down savings.
Borrowing from the banking system
Selling assets to residents in other regions
Long or short-term inward investment to reduce
dependence on imports
Regional and Local Economics (RALE) 2008
– Lecture 2a
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Local & Regional Economics
More Sophisticated Models
Demand-based model of income and employment
World income
Assumptions
 Positive response to
external shocks.
 Labour supply elastic
at current wage rates.
 Spare capacity - output
increased without
increasing price
 Regions are price
takers (wages are set
nationally)
Other regions
Demand for region’s output
Supply of output
Adapted from Armstrong and
Taylor (2000) pp 28
Demand for labour
Regional employment
Regional income
External
Demand
Weakness of the model it Ignores the fact that an increase
in demand is likely to affect the price of factor inputs
Regional and Local Economics (RALE) 2008
– Lecture 2a
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Local & Regional Economics
Demand-based model
with supply-side
World demand
Regional
income
Demand for
region’s goods
1. Supply side is endogenous as demand affects
the labour market and the supply of output to
meet regional and world demand.
2. Wage rate is determined within the region as
labour market tightens
3. Increased regional wage rates induces further
supply of labour (participation and migration)
4. Increased regional wage rates reduce
competitiveness (production costs )
Region’s
employment
Unemployment
Supply of
labour
Price of
region’s goods
Wage rate
Participation
rate
Competitiveness
of region
Net inward
migration
Regional and Local Economics (RALE) 2008
– Lecture 2a
Adapted from Armstrong
and Taylor (2000) pp 30
14
Local & Regional Economics
Summary
 Cumulative effect on a regional economy is always greater
than initial injection but Impact reduces in subsequent
rounds
 Multiplier combination of Direct, Indirect and Induced
effects, there is also a feedback loop.
 Keynesian Income Expenditure model is useful for deriving
overall regional multipliers. Importance of MPC – size,
industry mix, location – can be extended.
 Importance of 1st round injections – applications,
universities, tourism, defence etc.
 But there are clear weaknesses in the approach.
 Multi-regional model shows the inter-connection between
regions, further developments have looked at the feedback
effect and the supply-side.
Next econometric models & input-output analysis
Regional and Local Economics (RALE) 2008
– Lecture 2a
15

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