Investment Multiplier

What is an 'Investment Multiplier'

An investment multiplier refers to the concept that any increase in public or private investment spending has a more than proportionate positive impact on aggregate income and the general economy. The multiplier attempts to quantify the additional effects of a policy beyond those immediately measurable. The larger an investment's multiplier, the more efficient it is at creating and distributing wealth throughout an economy.

BREAKING DOWN 'Investment Multiplier'

The investment multiplier tries to determine the financial impact for a public or private project. For instance, extra government spending on roads can increase the incomes of construction workers as well as the incomes of the suppliers of the materials necessary for the project. These people may spend some of this extra income in the retail sector, also boosting incomes of workers there as well. Furthermore, workers and businesses stand to gain from access to better roads.

Calculating an Investment Multiplier

The value of an investment multiplier is a function of several factors, including the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) of the people whose payment for labor constitutes the investment's expenditures such as construction workers, engineers and material suppliers in the previous example. If the marginal propensity to consume of a project's workers is 0.75, then 75% of the workers' income is spent on goods and services that produce income for another individual or business, and 25% of their income is withdrawn from circulation by means of savings, taxation or expenditures on foreign goods and services. This same project has an investment multiplier of 4, which means that for every $1 spent on investment, another $4 of income is generated. The investment multiplier is calculated as 1/(1-MPC), or 1/(1-0.75), in the example.

Economic Applications

There are many types of people with a vested interest in quantifying the investment multiplier of a particular project, including government officials, investors, financial analysts, real estate developers and neighborhood groups. Total output and job creation tend to be highest when dealing with commercial and real estate investments because investment costs are overshadowed by a wave of economic activity. Business cycle analysts, central bankers and policy planners study investment multipliers on an aggregate level to observe the general flow of wealth in an economy and to better understand certain variables such as employment, prices and the velocity of money supply. The concept of a multiplier effect is applied in many other areas, such as unemployment benefits and tax policy.

RELATED TERMS
  1. Deposit Multiplier

    A function that describes the amount of money created in a bank's ...
  2. Earnings Multiplier

    An adjustment made to a company's P/E ratio that takes into account ...
  3. Marginal Propensity To Invest

    The ratio of change in investment to change in income. The marginal ...
  4. Equity Multiplier

    The ratio of a company’s total assets to its stockholder’s equity. ...
  5. Fiscal Multiplier

    The ratio in which the change in a nation's income level is affected ...
  6. Marginal Propensity to Save

    The proportion of an aggregate raise in pay that a consumer spends ...
Related Articles
  1. Markets

    What's a Multiplier?

    A multiplier attempts to measure the effect of aggregate spending over time.
  2. Markets

    Equity Multiplier

    The equity multiplier is a straightforward ratio used to measure a company’s financial leverage. The ratio is calculated by dividing total assets by total equity.
  3. Markets

    Understanding the Multiplier Effect

    The multiplier effect is an economic term referring to how an increase in one economic activity can cause an increase throughout many other related economic activities.
  4. Investing

    How To Value A Real Estate Investment Property

    Two common methods for real estate valuation are the discounted net operating income and gross income multiplier approaches.
  5. Markets

    Explaining Marginal Propensity To Save

    The marginal propensity to save is the proportion of a raise in pay that is saved instead of spent.
  6. Personal Finance

    How To Value A Real Estate Investment Property

    Make sure you know what your real estate investment is worth before you sign the ownership papers.
  7. Markets

    Explaining Marginal Propensity to Consume

    The marginal propensity to consume is a measure of how much consumption changes when income changes.
  8. Markets

    Calculating the Consumption Function

    The consumption function shows the level of consumer spending as it relates to disposable income.
  9. Markets

    Macroeconomics: Supply, Demand and Elasticity

    By Stephen Simpson DemandDemand is driven by utility – the pleasure or satisfaction that a consumer obtains from consuming a good or service. Total utility is a function of the quantities ...
  10. Personal Finance

    All About Income

    Income is the money you or a business earns by providing goods or services, or through investments.
RELATED FAQS
  1. Why is the multiplier effect associated with Keynesian economics?

    Learn what the Keynesian multiplier effect is and how it provided a justification for increased government spending in the ... Read Answer >>
  2. What is the difference between the deposit multiplier and the money multiplier?

    Explore the deposit multiplier and the money multiplier, two fundamental concepts of Keynesian economics, and learn how they ... Read Answer >>
  3. How can a change in fiscal policy have a multiplier effect on the economy?

    Learn about how changes in fiscal policy have a multiplier effect on the economy. The goal of expansionary fiscal policy ... Read Answer >>
  4. What does a large multiplier effect signify?

    Find out more about the multiplier effect, what it measures and what a large multiplier effect indicates about an economy. Read Answer >>
  5. How does monetary policy affect a bank's deposit multiplier?

    Find out how the Federal Reserve uses monetary policy to impact the deposit money multiplier for American banks, including ... Read Answer >>
  6. Which is better: A high or low equity multiplier?

    Learn about the equity multiplier, how it is calculated, what it measures and why a low equity multiplier is preferred to ... Read Answer >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center