Economic Impacts 101: Understanding the Basics of Economic Impact Studies

Economic impact studies are an excellent tool for developing policy, making site selection decisions, and communicating the importance of your project. Learning their language is central to putting the results to work. Today, I want to share my Economic Impacts 101 lecture (in written form) so you can explain your results, defend their legitimacy, and share your findings with confidence.

Before we begin, a quick note on my background. I’ve worked on economic impact studies for over a decade. I worked as a tenured professor teaching research methods before supporting the National Oceanic and Atmospheric Administration as a contracted natural resource economist, and today I’m the Lead Economist at Vista Site Selection. I’ve led 110 economic impact studies and counting, covering manufacturing, construction, education, utilities, and (my personal favorite) recreation. I’ve also published 46 peer-reviewed journal articles and an academic book using clear, replicable methods. I’m a leading expert on the economic impacts of rock climbing. I’m also one of about 40 IMPLAN Certified Economists, and I’m proud to be part of the extraordinary Vista economics team.

Below, I’ll walk you through the core terms (direct, indirect, and induced effects plus our four impact measures), study areas, leakages, and taxes. Feel welcome to reach out to me personally about your own study at any point.

Input-Output Modeling and Key Terms

Economic impacts are calculated using an input-output model, a method economist Wassily Leontief developed in the 1930s and 1940s (and won the 1973 Nobel Prize for). The model uses a grid of every industry in an economy to show how they buy from and sell to one another. We enter a project’s spending, and the model traces how those dollars move between industries, households, and government over a set period.

Multipliers are the heart of this analysis. A multiplier describes how a change in one industry ripples through a specific economy. For example, if every dollar spent generates another $0.25 of local activity, the multiplier is 1.25. Multipliers exist for jobs, labor income, value added (a region’s contribution to gross domestic product, or GDP), and output (which is roughly sales).

Common input-output tools include IMPLAN, RIMS II, and REMI. All of them draw mainly from the Bureau of Economic Analysis input-output accounts and then add their own data sources. (I’ve used all of them but typically rely on IMPLAN for its precision, transparency, and ability to adjust scenarios with real data. I lean on licensed labor-market data for industry and labor summaries.)

Economic Impact Effects

Economic impact studies report three levels of effects. The direct effect is the change the analyst enters into the model to represent the activity being studied. I usually get this data from my client, whether that’s the number of jobs they’re adding or a change in their spending.

Indirect effects are business-to-business purchases. When the direct business buys materials and services from local firms, that spending is the indirect effect. More rounds follow as those suppliers buy from their own suppliers.

Induced effects are household spending. Workers at the direct business and throughout its supply chain earn income and spend it locally on their household needs. (We subtract taxes and savings first, and we leave out commuters who work here but live elsewhere.)

You’ll sometimes hear these grouped as Type I and Type II. Type I includes direct and indirect effects, while Type II adds induced effects. All three keep rolling until the original spending works its way through the economy and leaks out of the study area. More on that in a moment, but first I promised you a local example.

Case Study: Economic Effects in Action: Kentucky’s Red River Gorge

Kentucky’s Red River Gorge is a famous rock climbing destination dear to my heart, even though I’m not a rock climber. (Go read my book on the Red if you’d like to learn more!) Climbers visit from across the globe (though mostly from Kentucky, Ohio, Indiana, and Tennessee in my experience) and spend money on food, lodging, retail, and services. That spending is our direct effect.

I love the locally owned restaurants there, so let’s follow the food. When climbers buy pizza, burritos, and barbecue, the restaurants need more butter, flour, and meat. Those supply purchases are indirect effects. Their vendors then restock from other businesses, which adds more indirect rounds. Some vendors are local (like farms growing vegetables nearby), while others are in Lexington, Kentucky, about an hour away, or even farther.

Meanwhile, workers and owners at the restaurants and their suppliers are earning income. When they pay utilities, buy groceries, or head right back to those extraordinary restaurants in the Red, we get induced effects. This continues until the climbers’ spending has worked through the economy and left the area in some form.

Leakages are Normal?

That last point brings us to leakages. Sounds terrifying, I know, but leakages are normal and quite common. Some products and services are hard to find near the Red. One of my recent studies found that climbers planned around this by stopping in Lexington for groceries because options closer to the Red were limited. Local businesses face the same challenge with things like tax services, sales software, and kitchen supplies. Any money spent outside the region is a leakage.

Leakages are what keep an impact from multiplying forever. Each round of spending loses some dollars to other regions, so the effects shrink until they fade out. (This is exactly why we’re encouraged to shop local. Those dollars stay in your regional economy a little longer.)

Study Areas: Building a Sandbox for Your Analysis

So far I’ve used vague phrases like “regional economy,” but the formal term is study area. A study area covers where the direct activity happens and the region we watch for its spinoff effects. Anything inside its boundaries counts as local, and anything outside is left out.

A study area can be as small as a single county or as large as the whole nation. It can also combine several counties or states into one region. That choice matters because the boundaries shape the multipliers. Larger areas usually hold more of the suppliers and shops people spend money with, so less leaks out and the effects run longer. Smaller areas lose more to outside purchases. (It’s also worth asking whether growth in your study area is just activity pulled away from a neighbor.)

Skilled economists (like the team here at Vista) often run more than one model. Sometimes we link study areas through multi-regional input-output analysis (MRIO). Other times we test whether a study area can absorb the direct effects at all. For the Red, I combined five counties that captured where climbing happens and where climbers spend during their trips. I also built a Commonwealth-wide model to catch spending beyond those five counties, like those grocery runs to Lexington.

Measures of Economic Impacts

Direct, indirect, and induced effects are each reported across four measures. These are employment, labor income, value added, and output. (These definitions come from IMPLAN, but other software works in similar ways.)

Measure	What it captures	What’s inside it
Employment	Jobs, counted as an annual average of full-time, part-time, and seasonal positions	Wage-earning employees and self-employed owners (not the same as full-time equivalents)
Labor income	What that work pays	Wages, salaries, benefits, payroll taxes, and what owners earn from their businesses
Value added	What businesses create beyond what they buy from others (a region’s GDP)	Labor income, other property income (profits, rents, and similar returns), and taxes on production and imports
Output	The total value of production (roughly sales for most projects)	Value added plus intermediate inputs (goods and services used up in production)

One important reminder is that we don’t add these numbers together. Labor income sits inside value added, and value added sits inside output. (Adding them would count the same dollars two or three times.) Also, since employment is an annual measure, one person holding the same job for five years shows up as five job-years.

What About Taxes? Fiscal Impact Analysis

Taxes are a critical part of economic impact studies, and in my experience this is where most studies fall short. Tax studies (typically called fiscal studies) examine how the direct activity generates taxes within the study area. Impact software provides basic tax results, but these have real gaps. The models handle federal and state taxes well but can’t capture the details of local taxes. On one recent project, a local tax rate varied by business size, so we examined every business in that industry to find the right rate. We also see combined city and county rates that software assigns only to the county. And software simply can’t model the depreciating value of machinery and equipment.

That’s why Vista Site Selection uses its own fiscal methodology. Our interactive models estimate taxable activity at the federal, state, county, city, village, and other levels. I say with confidence that our tax analyses are among the best in the industry (if not the best, although I’m biased here) for detail, reliability, and precision.

Congrats! Let’s Get to Work on Your Study!

So there we have it. You now have the basic vocabulary needed to understand an economic impact study. We’ll share more of these help sheets soon covering what we can model, common misconceptions, and common errors I see in other economists’ work. For now, know that I’d love to chat about your study, how we model things so no spending is left on the table, and how we communicate the value of your industry. Reach out and let’s set up a time to learn more about your project!

Frequently asked questions

What is an economic impact study?

Economic impact studies are an excellent tool for developing policy, making site selection decisions, and communicating the importance of your project. Economic impacts are calculated using an input-output model: we enter a project’s spending, and the model traces how those dollars move between industries, households, and government over a set period.

What are direct, indirect, and induced effects?

The direct effect is the change the analyst enters into the model to represent the activity being studied. Indirect effects are business-to-business purchases. Induced effects are household spending: workers at the direct business and throughout its supply chain earn income and spend it locally on their household needs.

Why shouldn’t you add labor income, value added, and output together?

Labor income sits inside value added, and value added sits inside output. Adding them would count the same dollars two or three times. It’s also completely incorrect.

How does the study area change the results?

The boundaries shape the multipliers. Larger study areas generally, but not always, reduce leakages and increase multipliers. This is why I encourage folks to start with counties rather than ZIP codes.

What is the difference between an economic impact study and a fiscal impact study?

Tax studies (typically called fiscal studies) examine how the direct activity generates taxes within the study area. Impact software handles federal and state taxes well but can’t capture the details of local taxes, which is why Vista Site Selection uses its own fiscal methodology.

Which numbers matter most in an economic impact study?

Vista typically focuses on jobs and output. In my studies I also like to bring up labor income, as it communicates well with politicians.

How long does an economic impact study take?

We generally get results back in one month. It’s best to talk with us about pricing, as every study is different.