As citizens in a democracy we have many tools to help us manage our economy for the good of the country as a whole and for the good of ourselves as individuals. But the successful use of these tools requires thoughtful consideration of the direct and indirect consequences of any governmental action including governmental inaction. As these words are being written the country is in the midst of a noisy but not very informative debate about economic policy.
One of the most important properties of a complicated economy like our soon-to-be 21-st century economy is the way that any action in one part of the economy has consequences elsewhere -- every action (or inaction) has both direct and indirect consequences. In this module we look at one particular simple example of this phenomenon.
There are many actions that the government and private industry can take to stimulate the economy in a particular place -- for example, building a new facility that employs a large number of people. This will have an immediate direct effect -- the creation of new jobs. But this direct effect will have other consequences -- for example, new employees will have money to spend and will require food, housing, and other products and services. This will in turn create additional jobs. And these new jobs will themselves create new jobs and so forth. Typically, if the direct effect of some action either by government or by private industry is a payroll of A dollars then this payroll will create a secondary payroll of R A and this secondary payroll will itself create a tertiary payroll of R2 A and so forth. Thus, the total effect of the initial payroll will eventually be a payroll of
A + A R + A R2 + A R3 + ...
Another important variable in this situation is the speed with which the local economy can react to new jobs and the needs of new employees. A depressed area with lots of vacant stores and unemployed workers may be able to react much more quickly than an affluent area in which new growth requires new buildings and workers from outside the area. The cycle time for a particular situation is the time it takes for each new job to produce its secondary effects. For example, if the cycle time was three months then after one year an initial direct payroll of A dollars would produce a total payroll of
A + A R + A R2 + A R3
Example:
If R = 0.75 and the cycle time is three months then an initial payroll of A dollars will produce a total of 2.73 A jobs in one year.
Make a table showing the total payroll produced in the first year by a direct payroll of A dollars for R = 0.80, 0.70, 0.60, 0.50, and 0.40 with the following cycle times -- one month, two months, three months, four months, and six months. Make a second table showing the total payroll eventually produced by a direct payroll of A dollars for R = 0.80, 0.70, 0.60, 0.50, and 0.40.