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© Harry Campbell & Richard Brown
School of Economics
The University of Queensland
BENEFIT-COST ANALYSIS
BENEFIT-COST ANALYSIS
Financial and Economic
Financial and Economic
Appraisal using Spreadsheets
Appraisal using Spreadsheets
Ch 13: Economic Impact Analysis
What is the difference between Net Present Value
and Economic Impact?
Keynes gives the example of land, labour and capital used in two
alternative ways:
1. To dig a hole in the ground;
2. To build a hospital.
The two projects have the same economic impact, in terms of
generating income for factors of production and inducing additional
expenditures, but the hospital has a higher net present value than the
hole in the ground.
Figure 13.1 The Circular Flow of Income
$ GOODS FACTORS $
GOVERNMENT
HOUSEHOLDS
FIRMS
The Circular Flow of National Income
The National Income Multiplier
Consider three models which can be used to derive the national
income multiplier:
1. A closed economy, no taxes;
2. A closed economy, with exogenous taxes;
3. An open economy, with endogenous taxes.
Symbols:
Y = national income; C = consumption expenditure;
S = Savings; I = investment expenditure;
T = tax revenues; G = government expenditure;
X = value of exports; M = value of imports
Model 1: Closed economy, no taxes
Y = C + I + G
C = A* + bY,
where A* is autonomous consumption expenditure, and
investment and government expenditure are exogenous.
Substitute to get:
Y = A* + bY + I* + G*
where “ * ” indicates a variable which is exogenous to the model
(i.e. is assumed to be constant).
Solve to get:
Y = (1/(1-b))(A* + I* +G*),
where (1/(1-b) is the national income multiplier.
Now dY = (1/(1-b) dG*
Model 2: Closed economy, with exogenous taxes
Y = C + I + G
C = A + b(Y - T)
Substitute:
Y = A* + b(Y - T*) + I* + G*
Solve:
Y = (1/(1-b)(A* + I* + G* - bT*)
Now:
dY = (1/(1-b)(dG* - bdT*)
Note that if extra government expenditure is financed
by increasing tax revenues, dG* = dT*,
dY = dG*
i.e. the balanced budget multiplier is 1.
Model 3: Open economy, with endogenous taxes
Y = C + I + G + X - M
Note that X is added because income is generated in production
of exports, but the component of C+I+G that represents imports
(M) is subtracted because no domestic income is generated by
imports.
C = A + b(Y - T)
T = tY
M = mY
Substitute:
Y = A* + b(Y - tY) + I* +G* + X* - mY
Solve:
Y = [1/(1-b(1-t)+m)](A* + I* + G* + X*)
Using plausible values: t=0.3; m=0.25; b=0.9, the multiplier
takes the value 1.45.
The Employment Multiplier
Suppose that average per worker income is $y. The number of
‘jobs’ in the economy is, therefore: L = kY, where k = 1/y.
The extra number of jobs resulting from an increase in
government expenditure is, therefore: dL = kdY , which, from
Model 3, can be written as: dL = k[1/(1-b(1-t)+m)]dG* ,
where k[1/(1-b(1-t)+m)] is the employment multiplier.
Some points to note:
1. The size of the multiplier is inversely related to the size of the
‘leakages’: (1-b), t, m.
The smaller the region (extent of the referent group) the larger the
leakage caused by imports, and the smaller the multiplier.
2. National income, Y, is expressed in nominal terms. We can
think of Y being the product of the average price of goods and
services, P, times the quantity produced, Q.
Y = PQ
An increase in Y could be caused by changes in P and/or Q:
dY = dP.Q + P.dQ
but only changes in Q generate changes in real income.
In other words, some of the multiplier effect could represent
inflation.
3. Any project involving the use of scarce factors of production will
generate income and, hence, expenditures and a multiplier effect. In
comparing the economic impact of projects, it is the relative
multiplier effects that count, and these may not differ significantly.
4. Multiplier effects may be particularly associated with the
construction phase of a project, and, in that case, will be of limited
duration.
5. Multiplier effects can be considered a benefit of the project only
in so far as they are ‘real’ (i.e. represent the value of extra output
net of any additional opportunity costs), and would not have
occurred in the absence of the project (i.e. would not have been
generated by an alternative project).
[...]...Inter-Industry Analysis Table 13.1: Inter-Industry Structure of a Small Closed Economy _ Sales Final Demand Gross Output 1 2 3 _ Purchases 1 100 400 300... industries: y = 0.9 x1 + 0.6 x2 + 0.4 x3 When this equation is added to the other three and the system solved for national income, y, the following result is obtained: y = 10(g1 + g2 + g3) Inter-industry Analysis and Employment Suppose that the level of input of factor of production i to industry j is given by: vij = bij xj Where bij is a coefficient and xj is gross output of industry j as before Supposing... change in the level of autonomous demand for any of the three goods can be traced back through this system of equations to calculate the effects on the levels of the factor inputs General Equilibrium Analysis A computable general equilibrium (CGE) model can be constructed to determine the equilibrium values of prices and quantities traded in the economy, and to calculate the changes in these values . Brown
School of Economics
The University of Queensland
BENEFIT-COST ANALYSIS
BENEFIT-COST ANALYSIS
Financial and Economic
Financial and Economic
Appraisal. Spreadsheets
Appraisal using Spreadsheets
Ch 13: Economic Impact Analysis
What is the difference between Net Present Value
and Economic Impact?
Keynes gives the example
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