The Macroeconomic Concept Of The Multiplier Economics Essay

Currently, China’s economic is growing rapidly. Living standard of the people has improved and urban & rural income has substantially improved. The balance of the household shaving is increasing year by year and china has maintained a high saving rate. The marginal propensity of consume trend to drop, which is extremely unfavorable for the future development of the country economy and it will directly affect the growth rate of GDP. So, all this will become fetters in the process of the development of the economic.

In this paper, I will evaluate the extent to which a thorough understanding of the macroeconomic concept of the multiplier would help government to manage their own macro economy.

Macroeconomic

Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. (Burda & Wyplose,2005) Macroeconomists develop models that explain the relationship between factors such as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. (Sloman, 2006)

While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations (Griffiths &Wall, 2008) in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income).

3. Macroeconomic Multiplier theory

Macro-economic multiplier theory is based on marginal propensity to consume by the British economist J.M. Keynes, which explains the relationship of multiples theory between investment and income. The Keynesian multiplier theory is an extension of the field in the international balance of payments, in terms of constant exchange rates and price. It analyzes that income adjustment play a role in the international balance of payments. Its basic content is that investment change brings the impact to the total national income greater than the investment itself, such as a change is often a multiple of the investment changes. (Sloman & Wride, 2006). As economic sectors are interrelated, so an investment in a particular sector will not only increase the income of this sector, but also cause a chain reaction in the various sectors in the national economy, thereby increasing investment and income of other sectors, increase of multiplier the national income exponentially. In fact, the multiplier formula simply gives the multiplier as the inverse of the marginal propensity to withdraw (mpw):

K=1/mpw. (Sloman, 2006:464). (Show below figure1-3)

Figure 1: The multiplier: a shift in injections (Source: Sloman & Wride 2006:488)

Multiplier ¼ â-³Y/â-³J ¼â-³Y/â-³W ¼ (c¼a)/(b¼c)

Figure 2: The multiplier: a shift in withdrawals (Source: Sloman & Wride 2006:488)

Multiplier ¼â-³Y/â-³W ¼ (c¼a)/(a¼b)

Figure 3: The multiplier: a shift in the expenditure function (Source: Sloman & Wride 2006:489)

Multiplier ¼ â-³Y/â-³J ¼ (c¼a)/(b¼a)

4. The current macroeconomic situation in China

Presently, China is facing the most severe situation since the Asian financial crisis, which is the most difficult time of the economic development since the new century. In terms of the entitative economy, China is the one of the country in this round of financial crisis which is affected hardly. The industrial sector, energy and raw material sectors and the real estate sector have large impact in this financial crisis. ¼ˆChina country review, 2008¼‰. From the fourth season in 2008, China’s economic development problems start to show their impact as a result Industrial production and exports are declined, unemployment increased. From judgments of the country’s economic situation, the Government fully recognized the seriousness of the economy and from the macroeconomics of the multiplier made the measures to following:

4.1. Augment the multiplier to achieve increase in national income

In the short term, we can be augmenting the multiplier to achieve increase in national income i.e. raise the marginal propensity to consume and reduce the marginal propensity to save.

At present, China’s savings continue to increase and reached about 15 trillion Yuan, so there is a large potential of consumption. In this situation, the government application of the macroeconomics of the multiplier stimulates consumption. (Wilkinson, 2005:477) .Such as:

Reduce the bank deposit interest rates and the collection of interest on income tax;

energetically develop tourism, improving holiday economy;

improve the minimum subsistence level, increase laid-off workers and retirees personnel subsidies;

Appropriately reduce tax on consumption of the general goods, at the same time assess high tax on consumption goods of special.

For example, economic crisis haven’t just affected the issue of workers to return home, but also opportunities of employment. Survey show that from 2002 to 2007, there was an average increase of 5.6% in the migrant workers in the first half, but last year the amount of this growth was only 1.6%, about 4 % poorer than usual.(China Develop Institute 2008) By using multiplier theory, if you make a simple projection, (Wilkinson, 2005:144). i.e. 4 percentages is equivalent to 5.4 million people, these people should be roughly equivalent to the group of migrant workers who should have working out but lost the opportunities in the economic crisis situation. If we add the unemployed people to return home early in this year, this group of people (accounting for 15% of migrant workers) are about 25 million migrant workers who lost their jobs or jobs opportunities due to economic crisis.

4.2. Augment investment to achieve increase in the national income

In the long term, the marginal propensity to consume in a steady state, then the multiplier is fixed, so we need to increase investment and improve the national income. (Voyles, 2009)

In China, the government makes a lot of policy and adjust fiscal policy and monetary policy, adopted a proactive fiscal policy and appropriately loose monetary policy. There are production, consumption, investment, exports in various field, etc. Now, the state has invested 4 trillion Yuan (China Develop Institute, 2009) in railroad this year and next year, which will stimulate domestic demand. By 4 trillion Yuan package of investment programs, the central government invested 540 billion in this year. But there are 160 billion investments in the original budget this year, so after adjusting for new investments in the State this year was only 380 billion. If the multiplier effect is 1:3, then the central government can bring up more than 1 billion investments.

Therefore¼ŒGovernment expending is an important source by way of investment, which play an important role in the direction of investment and optimization the investment structure.

4.3. Export expansion to achieve increase in the national income

China is facing unprecedented opportunities and challenges since joined WTO, we must seized the opportunity and integrate with the international economy, improve the structure of export products and increase the proportion of high value-added exports, improve terms of trade, through external trade bring out the rapid development of the national economy to increase national income.

In recent years, the contribution of export in Chinese economics growth rate is around 20% (China Develop Institute, 2009), and now we have to compensate the sharp decline in exports by investment and consumption demand. By using multiplier theory, If the export growth rate is measured by the level of 10%, then the investment growth rate reach to 10% and 2 trillion Yuan of domestic investment and demand-pull may be achieved in the same year. In general, to maintain a GDP growth rate of 8%; if exports rate this year is 6%, it is very difficult to reach 8%, if it rely on 2 trillion domestic investment and demand-pull; if the exports this year have zero-growth, it is absolutely impossible if they rely on 2 trillion domestic investment and demand-pull to achieve 8%.

5. Drawbacks of the Multiplier theory

5.1. Ignores the time lags

In the Keynesian multiplier theory, investment, consumption, national income etc all of them are liquidity and change over time. The number of the increase can only be compared with the different periods of the same length. The increase in the periods of different length cannot be explained by using this theory. The Multiplier theory ignore the time lags discuss the flow of change that it is meaningless. (Sloman, 2006:475)

For example, in last year, China’s export was increased to 17%, where textile products have negative growth rate. Relatively, mechanical and electrical products had grown with a high growth rate. But now, it has begun to enter in the difficult term. Last year, China’s export of electromechanical products maintained a positive growth, as order form have a longer period for machinery and electronic products and as a impact of the time lags shrinking foreign order forms were fewer and start to increase on lay-off of the mechanical and electrical products manufacturing.

5.2. Ignore the difference of the capital flows and capital stocks

The multiplier can only exist in stock of the flow, such as money, loans, stock and so on. The multiplier can not exist in the capital flows (McAleese 2004:471), such as investment, consumption, demand, income, etc. and it cannot be extended to the flow of money.

For example, recently, China Eastern Airlines exposed that the gas has a loss of 6.8 billion Yuan and CITIC Pacific has lost 200 million Yuan. (China Develop Institute, 2009). The amount lost by companies is huge, due to the misleading by Multiplier theory. According to estimate, so far China’s financial institutions and enterprises has been loss of approximately 2 trillion Yuan in the overseas investment .Therefore, we can not focus only on the production and GDP growth.

6. Conclusion

Keynes’s multiplier theory is an important component of the system macro-economic theory. But multiplier theory has some drawback, as it ignores the distinction between capital flows and capital stock, ignores the factor of the time lags and led to wrong conclusions.

In this situation, where saving are high and consumption is less, application of the Keynes’s multiplier theory manage the country own macroeconomic. Firstly, through improving the social security system and consummate pension, unemployed, market of the medical insurance and the building of housing accumulation fund. Secondly, Growth accelerated from the current investment in China, demand has increased. Implementation of a positive fiscal policy and increased investment is necessary. The government needs to extend the consumption. Finally, In terms of the export tax rebate rate not high, the government can be used promptly refund in full rebate solution to bring part of the cash flow difficult problem for lag of the export tax rebate. In terms of the export credit, the government makes to encourage measures and to expand exports. Meanwhile, the active use of WTO preferential policies for developing countries to expand exports, optimize the export product mix, improved condition of the trade.