Economics of Induced Effects

by Corr S. Pondent - Updated September 26, 2017
Woman at the supermarket with her son

Economic impacts affect the level of activity in a local economy, either positively or negatively. A new factory built in a town could change the income of residents, or it could put an existing firm out of business. Economists engage in economic impact analysis to find out about such economic impacts, such as when a local government is considering whether to provide a permit to a new project. Some of these economic impacts also include what economists call induced effects.

Measuring Economic Impact

In order to measure economic impact, economists trace the course of spending through an economy and find out the total effect of that spending. They will first decide what the area of impact is where the economic impact is to be measured. This area could be the local economy, the state-level economy or even the national economy. These measurements are more likely to give an idea about the magnitude of the impacts, rather than their specific amounts.

Induced Effects

The total economic impact from a project includes not only its direct and indirect effects, but also its induced effects. The direct effect of a project consists, for instance, in the number of direct jobs it creates, and the indirect effects could consist of jobs created at a supplier’s factory. An induced effect consists of the impact of spending by the people employed in the project. For instance, they spend the money they earn on local goods and services, thereby providing a boost to the local economy.

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Example

Suppose an automobile parts manufacturer set up a factory in a particular town. The new plant will create jobs. Employees at the plant will go out and spend their money in the town. In addition, employees of the suppliers who supply materials to the automobile parts manufacturer will spend their money to meet their household needs. This activity will create new jobs and income. All this is part of the induced effect from the automobile parts factory.

Multiplier Effect

There is also a multiplier effect from economic activity. For instance, when a restaurant is set up in a town, it pays wages to its employees. These employees spend the money in the town, thereby creating an induced effect. But the economic impact doesn’t stop there. The outlet where the restaurant employee spends wages boosts its sales and engages in spending of its own. This is part of the multiplier effect. Thus, the economic impact from the restaurant also has ripple effects.

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