Chapter 4 Economics of Tourism

Chapter 4
The Economics of Tourism
Learning Objectives
1. To explain the role of tourism in economic development

2. To analyze the economic impact of tourism on a destination area
3. To differentiate the direct effects from the secondary effects of tourists’
expenditures on the economy of the host area
4. To elucidate the meaning of tourism multiplier and its effect on the
economy of the host country
5. To describe the undesirable effects of the economic aspects of tourism
6. To identify the strategies which can maximize the economic effects of
tourism
The Role of Tourism in Economic Development
Several developing countries have used tourism development as an

alternative to help economic growth. The reasons for this are: First, there is a
continuous demand for international travel in developed countries. Second, as
income in developed countries increases, the demand for tourism also increases
at a faster rate. Third, developing countries need foreign exchange to aid their
economic development.
The Organization for Economic Cooperation and Development (OECD) has

concluded that tourism provides a major opportunity for growth for countries
that are at the intermediate stage of economic development and require more
foreign exchange earnings.
Tourism is an invisible export, which differs from international trade in

many ways.
1. In tourism, the consumer collects the product from the exporting country,
thereby eliminating the freight costs for the exporter, except in cases in
which the airline used are hose of the tourist receiving country.
2. The demand for pleasure travel is largely dependent on non-economic
factors, such as local disturbances, political unrest, and changes in the
fashionability of resorts / countries created mostly by media coverage. At
the same time, international tourism is both price elastic and income
elastic. This means that changes in price and income will also change the
demand for pleasure travel.
3. By using specific fiscal measures, the exporting or tourist receiving country
can manipulate exchange rates so that those for tourists are higher or
lower (normally the latter is implemented in order to attract large number
of tourists) than those in other foreign trade markets. Also, tourists are
allowed to buy in domestic markets at the same prices as the local
residents (the exceptions are duty-free tourist shops operated in many
Caribbean islands and elsewhere).
4. Tourism is a multifaceted industry that directly affects several sectors in the
economy, such as hotels, shops, restaurants, local transport firms,
entertainment establishments, handicraft producers, and indirectly affects
many others, such as equipment manufacturers and utilities.
5. Tourism brings many more non-monetary benefits and costs than other
export industries, such as social, culture and environmental benefits, and
costs.
Economic Impact
When travelers outside the destination area spend on goods and services
within the destination, tourism acts as an export industry by bringing in revenues
from outside sources. Tourist expenditures also increase the level of economic
activity in the host area directly. Many countries have utilized tourism as a means
to increase foreign exchange earnings to produce investment necessary to finance
economic growth.
Tourism’s economic impact on a destination area can be immense since it

provides a source of income, employment, and foreign exchange.
Direct and Secondary Effects
In order to measure the economic impact of tourism on the destination area, it

is important to know the direct and secondary effects of visitor expenditures on
the economy of the area. Tourist expenditures received as income by businesses
such as hotels, restaurants, car rentals, tour operators, and retail shops serving
tourists have a direct effect on the economy of the host area. The term direct
means that the income is received directly. Indirect or secondary effects mean
that the money paid by tourists to businesses are in turn used to pay for supplies,
wages of workers, and other items used in producing the products or direct
services bought by tourists.
Tourism Multiplier
The term multiplier is used to describe the total effect, both direct and
secondary, of an external source of income introduced into the economy.
Tourism multiplier or multiplier effect is used to estimate the direct and secondary
effects of tourist expenditures on the economy of a country.
Cost-Benefit Ratio
Those concerned with developing the tourism industry, whether a government

or a private individual, would like to know the extent of potential benefits and
their costs. Benefits divided by costs equal the cost-benefit ratio. To arrive at
these ratios, the following procedures are used:
1. Determine where the tourist dollar is spent;

2. Determine what percentage of each expenditure leaves the local economy;
3. Derive a “multiplier effect,” a ratio applied to income that reflects multiple
spending within an economy;
4. Apply the multiplier effect to the tourist expenditure to arrive at the total
benefits of tourist expenditures in dollars;
5. Derive a cost-benefit ratio expressed as dollars received / dollars spent; and
6. Apply the cost-benefit ratios to tourist expenditures to provide estimates of
income and costs of tourist business to a community, for both the private
and public sectors.
Undesirable Economic Aspects of Tourism
Some undesirable economic aspects of tourism are higher prices and economic
instability. Because of additional demand and / or increased imports, tourist
purchases may result in higher prices in a destination are. This would mean that
local residents, would also have to pay more for products and services.
Since pleasure travel is a discretionary item, it is subject to changes in prices

and income. These fluctuations may result in economic instability.
How to Maximize the Economic Effect of Tourism
A. Growth Theories
Some economic growth theories have been proposed to maximize the

economic effect of tourism within a destination area. These are the theory of
balanced growth and the theory of unbalanced growth.
Proponents of the theory of balanced growth suggest that tourism should

be viewed as an important part of a broad-based economy. This theory stresses
that tourism needs the support of other industries. Its objectives is to integrate
tourism with other economic activities. To obtain maximum economic benefit,
tourism goods and services should be locally produced.
Supporters of the theory of unbalanced growth see tourism as the spark to
economic growth. While the proponents of the theory of balanced growth stress
the development of supply, supporters of the theory of unbalanced growth
emphasize the need to expand demand. As demand is increased though the
vigorous development of tourism, other industries will move to provide products
and services locally.
B. Economic Strategies
The key to maximizing the economic effects of tourism is to maximize the

amount of revenue and jobs developed within the region. To attain this objective,
some economic strategies have been adopted, such as import substitution,
incentives, and foreign exchange.
C. Import Substitution
It imposes quotas or tariffs on the importation of goods, which can be

developed locally. It also grants subsidies, grants, or loans to local industries to
encourage the use of local materials. Its objective is to minimize the leakage of
money.
D. Incentives
The wise use of incentives can encourage the influx of capital, both local
and foreign, necessary to develop tourism supply. The most common forms of
incentives are:
1. Tax exemptions / reductions on imported machinery, materials, etc;

2. Reduction in company taxation by means of favorable depreciation
allowances on investment, or special treatment in relation to excise taxes, sales
taxes, income taxes, turnover taxes, profit taxes, or property taxes;
3. Tax holidays (limited period);
4. Guarantee of stabilization of tax conditions (for up to 20 years);
5. Grants (for up to 30 percent of total capital costs);
6. Subsides (guaranteeing minimum level of profit, occupancy, etc.);
7. Loans at low rates of interest;
8. Provision of land freehold at nominal or little cost or at low rents;
9. Free and unrestricted repatriation of all or part of invested capital

profits, dividends, and interest subject to tax provisions; and
10. Guarantees against nationalization or appropriation.
Before implementing an incentive strategy, a destination should:
1. Examine the performance of the schemes of other countries in the light

of their resources and development of objectives;
2. Research the actual needs of investors;
3. Design codes of investment concessions related to specific development

objectives with precise requirements of investors; and
4. Establish targets of achievements and periodically monitor and assess the

level of realization of such targets.
E. Foreign Exchange
Many countries have placed restriction on spending in order to maximize

foreign exchange earnings. They have limited the amount of their own currency
that tourists can bring in and take out of the destination to ensure that foreign
currency is used to pay bills in the host region. Tourists may be required to pay
hotel bills in foreign currency. Visitors may be required to show that they have
enough money for their stay before they are permitted to enter the country or
they may even be required to enter with a specified amount of foreign currency
for the duration of their visit.

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Chapter 4 Economics of Tourism

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Chapter 4

The Economics of Tourism

1. To explain the role of tourism in economic development

The Role of Tourism in Economic Development

Several developing countries have used tourism development as an

The Organization for Economic Cooperation and Development (OECD) has

Tourism is an invisible export, which differs from international trade in

Tourism’s economic impact on a destination area can be immense since it

Direct and Secondary Effects

In order to measure the economic impact of tourism on the destination area, it

Those concerned with developing the tourism industry, whether a government

1. Determine where the tourist dollar is spent;

Undesirable Economic Aspects of Tourism

Since pleasure travel is a discretionary item, it is subject to changes in prices

How to Maximize the Economic Effect of Tourism

Some economic growth theories have been proposed to maximize the

Proponents of the theory of balanced growth suggest that tourism should

The key to maximizing the economic effects of tourism is to maximize the

It imposes quotas or tariffs on the importation of goods, which can be

1. Tax exemptions / reductions on imported machinery, materials, etc;

3. Tax holidays (limited period);

4. Guarantee of stabilization of tax conditions (for up to 20 years);

5. Grants (for up to 30 percent of total capital costs);

6. Subsides (guaranteeing minimum level of profit, occupancy, etc.);

7. Loans at low rates of interest;

8. Provision of land freehold at nominal or little cost or at low rents;

9. Free and unrestricted repatriation of all or part of invested capital

10. Guarantees against nationalization or appropriation.

Before implementing an incentive strategy, a destination should:

1. Examine the performance of the schemes of other countries in the light

2. Research the actual needs of investors;

3. Design codes of investment concessions related to specific development

4. Establish targets of achievements and periodically monitor and assess the

Many countries have placed restriction on spending in order to maximize

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