Question

Cities tend to grow when businesses decide that it is economically beneficial for them to locate there. However, not all types of firms have the same effect on city growth. Provide a detailed analysis of the multiplier effect and its impact on city growth. Include graphs.

Answer 1

Multiplier effects are driven primarily by market forces. An increase (or decrease) of one type of economic activity in a given city or region prompts an increase (or decrease) in demand for goods and services, which then triggers the development of other types of economic activity in the same region or city. An increase (or decrease) in income or employment in a local or regional economy triggered by the emergence of a new type of economic activity is called a multiplier effect. The multiplier is an attempt to quantify the power of a given economic trigger.

Two basic types of demand-driven multiplier: A supply type and and income type.

Supply-side effects arise when additional demand is generated by new or growing business enterprises, which enables their suppliers to grow as well. Income-type effects are the result of the increased purchasing power of households driven by wages and salaries offered by growing enterprises, which allows providers of consumer products to grow as well. The growth of one company or several companies multiplies the economic benefits in a given area by helping to drive the growth of other business entities. The businesses involved, in turn, generate increased demand for goods and services, which initiates another cycle of multiplier effects. Such ‘second--order’ effects prompt third-order multiplier effects, fourth-order multiplier effects, and so on.

The magnitude of each subsequent multiplier effect is increasingly smaller, which means that the number of iterations necessary to estimate the total multiplier effect is finite. Moreover, business growth increases tax revenue for local governments, which may be used to improve local infrastructure and public services.

In the economic literature, a stimulus in the form of an increase in a certain type of activity is known as a direct effect, supply-side effects are also known as indirect effects, and income-type effects are known as induced effects.

Multiplier effects generated by the creation of a new type of economic activity in a given area, for example a large new manufacturing facility, are of particular interest. Ultimately, multiplier effects resulting from any change in economic activity in a given area are important, regardless of when it started.

Multiplier effects include the growth of local enterprises as well as the development of suppliers of goods and services located in distant regions, and even abroad. The more contained multiplier effects in a city or region, the stronger their impact on the given city or region as drivers of cumulative economic growth. On the other hand, the ‘trickling’ of multiplier effects into areas outside of the city/region in question in the form of the purchase of goods and services positively affects such fringe areas.