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January 29, 2009

Ripple effects

When hearing reports about the potential effects of auto manufacturers reducing their operations, the term "ripple effect" is used to describe the total impacts. What exactly is this ripple effect, and why is it important in economics?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Let me explain this with an example. Say John Jones loses his job that pays $50,000. Obviously, this is a $50,000 loss to John. But if John had earned that $50,000, he probably would have spent most of it. Let's say he spends all of it. So that $50,000 in turn would have become further income to merchants and retailers and anyone else that John Jones had bought something from. Likewise, those merchants who received John Jones' income would have respent that money that they received on their suppliers, etc. So the point is that an initial amount of money, once it's spent, respent, respent, etc., etc., several times, ripples through the economy and actually has a much bigger total financial impact on the economy than the initial amount. Now as a rule of thumb, what you can do is to take something like John Jones' income of $50,000, and if you want to say, what's the total impact of that once it has been respent, roughly double it, and say that is going to result in a loss, if he were to lose his job, a total loss of about $100,000."

Posted by Dave at January 29, 2009 08:00 AM