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How does income multiply in the economy?

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Phillip Holland eNotes educator | Certified Educator

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Income multiplication is very important to the market economy.  When one receives income, one can spend it on many goods and services.  This provides jobs for the people who created those goods and services.  One can also save money at the local bank--this gives the bank money to loan for people who want to buy houses and cars.  

A good example of income multiplication is the connection between a factory and the community where it's located.  When the workers get paid, they shop at the local grocery store; this allows the grocery store workers to get paid as well.  The factory workers then go to the department stores and buy things for their families.  They make payments to the bank on their mortgages and car loans.  They may even enjoy some entertainment in the evening, such as at the movies.  All of this keeps the economy going and ensures that when the factory worker receives his/her check, everyone in the community benefits.  However, when the factory is relocated, the entire community suffers because there is less money.  

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Michael Koren eNotes educator | Certified Educator

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The multiplier effect is very important in our economy.  When people get money, they spend or save it.  When they spend it on something, that means somebody else is getting money.  Then that person spends money somewhere which means somebody else is getting money.  This process is repeated over and over expanding the income in our economy.  The same is true when people save money.  When they put it in the bank, the bank will loan some of that money to a person looking to borrow money.  The person who borrows money will either spend it on various products or invest it in a business.  If the person spends it, the process described above begins again.  If the person invests it in a job producing business, people will get money as workers are hired or as the business spends it on supplies, infrastructure, and materials.  This also allows the multiplication of income or money to occur.  This multiplier concept is a very key part of the growth of our economy.  Federal Reserve policies may impact how great or limited the multiplier effect will be by either raising or lowering interest rates.  The next time you spend money, know that it is impacting the growth of income throughout our economy.

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