The Multiplier Effect


Most businessmen understand the important aspect of production known as economy of scale. It means that as you produce more, the cost of each product will come down due to the existence of fixed capital or overhead cost. This fixed cost is spread over a larger quantity of products to lower the production cost for each unit.

On the other hand, consumption is more difficult to grasp because consumers are beyond the control of the businessmen. They must produce in response to consumer demand which is subject to personal judgment that can easily turn out wrong. One of the most important aspects of consumption is the multiplier effect. It means some important action can trigger an avalanche of demand that can bring in huge profits in a short period of time. What kind of action will create a multiplier effect is a million-dollar question.

The multiplier effect is obvious in the stock market when the price of a company stock moves up in a big way. This has more to do with investors’ psychology and its manipulation than actual demand. The multiple effect in the stock market comes from two sources. One is the instantaneous transmission of funds and information where a piece of good news can quickly generate global purchase of a company stock. The other is the psychology of the millions of small buyers who are led to think that the stock is going to rise, hence they rush in to push the price even higher. In this kind of orchestrated buying, it is easy to create a bubble because the price of the stock is fake and man-made, not real. Nevertheless, a bubble stock market regularly results in higher consumer spending and an overheated economy until it finally bursts.

A second example of multiplier effect is the government’s tax refund, which provides a short-term stimulus to the economy. Since the refund is a percentage of the tax already paid, it is considered by most people as an unexpected windfall that will be spent right away rather than put into savings. This guarantees that most of the refunds will be circulated back into the economy in a short time to create demands for goods and services. In turn, this will increase the hiring of people to produce to meet the increased demands. More hiring will in turn creates more spending. This goes on until the multiplier effect tapers off.

A third example of multiplier effect is the real demands that continue for the long term even being interrupted by recessions and wars. Let me cite a few obvious examples: transportation, communication, and energy consumption. These are the areas where the masses of people are brought into the picture to create a multiplier effect in a global scale never seen before in history. How? The advance in computer and information technology has made it happen by reducing cost and increasing access. All you need is to look at the explosive growth of personal computers and cell phones, which are connected by the Internet that provides almost free access. When the masses are involved on a global scale, the multiplier effect becomes huge. A company that knows how to harness the new forces of the modern world will be able to reap the benefits of the tremendous multiplier effect.

September 2013

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About stockfessor

I like humors, music and karaoke.
This entry was posted in 21st Century, Business/Investment, Game Changer, Inspiration. Bookmark the permalink.

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