What is an Investment Multiplier?

An investment multiplier is a financial concept or idea that is associated with investment activity. The general understanding is that if there is any increase in the amount of private or public investment spending, the impact made by this activity will generate a positive impact on the general economy that is somewhat greater than one be expected. From this perspective, the multiplier is an attempt to look beyond the immediately measurable benefits derived from the activity, identifying and attempting to quantify secondary benefits that also occur.

Employing an investment multiplier requires several steps. The first involves identifying the immediate and main benefit that is generated by the investment activity. From there, closer scrutiny can make it easier to identify additional benefits that begin to amass in somewhat of a chain reaction to the initial activity. As those other benefits are identified, there is sometimes an attempt to determine what events those activities triggered, and what impact they in turn had on the economy.

An example of how an investment multiplier takes place is to consider a consumer who uses his or her disposable income to buy a secondhand car. The previous owner decides to save ten percent of the proceeds from that sale and use the other ninety percent to buy a new motorcycle. The dealer who sold the motorcycle in turn saves a portion of the funds received, but uses the rest to purchase motorcycle gear from a supplier. This series of events indicates that above and beyond the benefit generated from the initial transaction, subsequent transactions that occurred as a result of that first action generated additional benefits to the economy.

In the case of applying the concept of an investment multiplier in a government situation, assume that a local municipality chooses to embark on a repaving project in one part of town. This investment decision helps to increase the income of the road builders and pavers who work on the project. They in turn are likely to save a portion of that increased income, but spend the rest for goods and services they want or need. This allows the vendors who supplied those goods to in turn pay their employees higher wages, ultimately generating even more benefit for the local economy.

Investors, civic planners, and many corporations consider the idea of the investment multiplier when evaluating the viability of launching a new project. By identifying the primary benefits associated with the project, it is possible to determine if it is actually worth the time and resources involved. From there, assessing the second benefits that occur as part of the ongoing influence of that initial decision may help to further justify the project, and make it easier to understand the long-term ramifications of the action.