The Impact of an Identical Demand Shock on Two Cities

Abstract

It is generally agreed that in a larger, more diversified, economy, leakages are weaker, and multipliers, greater. But how great are the differences? And how significant are the effects of diversity, relative to other factors? These questions are examined using two applied general equilibrium models, one for the Quebec metropolitan area, and the other for the Montreal area. Both models, identical in format, were calibrated from regional social accounting matrices based on the same methods and data sources. By simulating the economic impact of identical exogenous shocks on each of the two economies, it was possible to quantify the differences in the values of the multipliers: they are quite variable, ranging from 8 percent to 33 percent when induced consumption effects are taken into account, and from 2 percent to 27 percent otherwise. In general, differences are smaller for demand shocks that include a substantial fraction of direct labor and other factor income. Controlled simulation experiments show that neither the share of income paid to resident households, nor the households’ propensities to consume seem to play a critical role. So it appears likely that the key factor is indeed size and the diversity of productive capacities, as it is reflected in local suppliers’ market shares.