Category Archives: Finance
The multiplier effect
Every time there is an injection of new demand into the circular flow there is likely to be a multiplier effect. This is because an injection of extra income leads to more spending, which creates more income, and so on. The multiplier effect refers to the increase in final income arising from any new injection of spending.
The size of the multiplier depends upon household’s marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps). It is important to remember that when income is spent, this spending becomes someone else’s income, and so on. Marginal propensities show the proportion of extra income allocated to particular activities, such as investment spending by UK firms, saving by households, and spending on imports from abroad. For example, if 80% of all new income in a given period of time is spent on UK products, the marginal propensity to consume would be 80/100, which is 0.8.
The following general formula to calculate the multiplier uses marginal propensities, as follows:
Hence, if consumers spend 0.8 and save 0.2 of every £1 of extra income, the multiplier will be:
Hence, the multiplier is 5, which means that every £1 of new income generates £5 of extra income.
The multiplier effect in an open economy
As well as calculating the multiplier in terms of how extra income gets spent, we can also measure the multiplier in terms of how much of the extra income goes in savings, and other withdrawals. A full ‘open’ economy has all sectors, and therefore, three withdrawals – savings, taxation and imports.
This is indicated by the marginal propensity to save (mps) plus the extra income going to the government – the marginal tax rate (mtr) plus the amount going abroad – the marginal propensity to import (mpm).
By adding up all the withdrawals we get the marginal propensity to withdraw (mpw). The multiplier can now be calculated by the following general equation:
When to refer to a ‘multiplier effect’
The multiplier concept can be used any situation where there is a new injection into an economy. Examples of such situations include:
- When the government funds building of a new motorway
- When there is an increase in exports abroad
- When there is a reduction in interest rates or tax rates, or when the exchange rate falls.
The downward or ‘reverse’ multiplier
A withdrawal of income from the circular flow will lead to a downward multiplier effect. Therefore, whenever there is an increased withdrawal, such as a rise in savings, import spending or taxation, there is a potential downward multiplier effect on the rest of the economy.
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West Texas Intermediate (WTI) crude oil is of very high quality, because it is light-weight and has low sulphur content. For these reasons, it is often referred to as “light, sweet” crude oil. These properties make it excellent for making gasoline, which is why it is the major benchmark of crude oil in the Americas. WTI is generally priced at about a $5-6 per barrel premium to the OPEC basket price and about $1-2 per-barrel premium to Brent.
Brent Blend is a combination of crude oil from 15 different oil fields in the North Sea. It is less “light” and “sweet” than WTI, but still excellent for making gasoline. It is primarily refined in Northwest Europe, and is the major benchmark for other crude oils in Europe or Africa. For example, prices for other crude oils in these two continents are often priced as a differential to Brent, i.e., Brent minus $0.50. Brent blend is generally priced at about a $4 per barrel premium to the OPEC Basket price or about a $1-2 per barrel discount to WTI.
The OPEC Basket Price is an average of the prices of oil from Algeria, Indonesia, Nigeria, Saudi Arabia,Dubai, Venezuela, and Mexico. OPEC uses the price of this basket to monitor world oil market conditions. OPEC prices are lower because the oil from some of the countries have higher sulphur content, making them more “sour”, and therefore less useful for making gasoline. The NYMEX futures price for crude oil is reported in almost every major U.S. newspaper.
It is the value of a 1,000 barrels of oil, usually WTI at some agreed upon time in the future. In this way, the NYMEX gives a forecast of what oil traders think the WTI spot price will be in the future. However, the futures price usually follows the spot price pretty closely, since the oil traders can’t know about sudden disruptions to the oil supply, etc.
How Crude Oil Prices Affect the U.S. Economy:
How Crude Oil Prices Affects You:
Crude Oil Price Trends:
An investment that is not one of the three traditional asset types (stocks, bonds and cash). Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.
WHY ALTERNATIVE INVESTMENTS?
Yesterday’s portfolios may no longer be enough for today’s challenges. In many cases, the traditional mix of stocks, bonds and cash – the core of modern portfolio theory – has proven more correlated than not in the new global economy.
ALTERNATIVES CAN CAN OFFER OPPORTUNITIES IN TODAY’S ENVIRONMENT
- Alternative investments offer the ability to extract better
relative returns with less correlation to the markets
- Market dislocations and regulations are creating opportunities
across the spectrum of alternatives
- In some instances, investors need to expand their investment
horizon to capture an illiquidity premium
- A well constructed, diversified portfolio of alternatives can provide
attractive risk-adjusted returns with downside and inflation protection
and less correlation to traditional market indices.
ALTERNATIVE INVESTMENT CHARACTERISTICS
Non-traditional asset classes, such as hedge funds, real estate, commodities and private equity, follow different rules than equities and bonds. This is precisely why they can help improve a portfolio’s risk/return profile.
- Risk/return characteristics are above average: Non-traditional investments can offer above-average returns with comparatively low volatility.
- It pays to adopt a longer investment horizon: Some non-traditional investments are long-term, calling for an investment horizon of several years or a holding period corresponding to the length of an economic cycle.
- Stability for the portfolio: Because returns on non-traditional investments depend upon different facts than those influencing traditional instruments, they have a balancing effect on a portfolio.
- Know-how makes the difference: Many non-traditional strategies and investments require solid specialist know- how, excellent market expertise and many years of experience. For this reason, manager selection is critical.