Accelerator Theory

What is Accelerator Theory?

According to the accelerator theory, a Keynesian concept, capital expenditure is a function of output. Capital investment spending, for instance, would rise proportionately to a rise in national revenue, as determined by the GDP.

Understanding the Concept of Accelerator Theory

The accelerator concept of economics illustrates that investment spending rises when either demand or income rises. This concept also asserts that businesses can either raise prices to reduce demand when there is a surplus of it or they can expand investment to satisfy the demand. According to the accelerator concept, businesses often decide to raise production, which also raises profits, in order to reach their fixed capital-to-output ratio.

According to the fixed capital-to-output ratio, if a single machine could only create 100 units, but demand increased to 200 units, then an additional machine would need to be purchased to satisfy the increased need. The accelerator impact might catalyze the multiplier effect, although there is no direct relationship between the two from the perspective of macroeconomic policy.

The accelerator theory is criticized by some since it completely eliminates the idea of controlling demand through price regulations. Nonetheless, empirical research backs up the idea.

Example of Accelerator Theory

Take a look at a sector where demand is increasing rapidly and strongly. The companies in this sector react to the rise in demand by increasing production or output and making full use of their current production or manufacturing capabilities. Some businesses might also respond to increased demand by selling off current inventories.

A business in a sector will probably decide to raise spending on capital goods-like machinery, technologies, and factories-to further enhance its manufacturing capacity if there is a strong indication that this increased demand level would be continued for a longer period. As a result, increased demand for the firm's goods/products drives demand for capital goods. This causes the "accelerator effect", which asserts that when demand for consumer products changes (in this case, increases), demand for capital goods changes by a greater percentage.

Investment in wind turbines is an illustration of a positive "accelerator effect". The need for renewable energy is rising due to fluctuating oil and gas prices. More investment is being made in wind turbines and other energy sources to match this need. The dynamic, though, can also work the other way around. Wind farm developments might be delayed if oil prices fall since renewable energy is less profitable commercially.

Difference between Multiplier and Accelerator

People frequently mix up multiplier and accelerator even though they are two different economic concepts. While the accelerator shows how changes in production and consumption impact investments, multipliers show how changes in investment impact income and employment. Both economic ideas attempt to demonstrate how investments and production/consumption are related to or interact with one another. Consumption depends on investment for the multiplier, whereas investment depends on consumption for the accelerator.

According to the multiplier theory, when investment grows, income/revenue grows by a multiple of that amount. Accelerator theory indicates that investment will rise by a multiple of the amount of rising income or consumption. The number of commodities/goods that must be produced/manufactured will rise as income and consumption among the population rise.

If the previously provided capital is entirely utilized, additional capital will be needed to manufacture them. Because the investment in this situation is induced by changes in income or consumption, it is referred to as an induced investment. The accelerator is a numerical representation of the relationship between the rise in investment and the rise in revenue/income.

If national income/earnings rise, net induced investment would be positive, while induced investment might drop to zero if national income or output remains constant. A certain amount of capital is required to produce/generate a specific output.

Criticism of the Accelerator Theory

In recent years, the acceleration concept has received much criticism from many. For instance, it has been pointed out that one cannot assume that the accelerator would remain constant throughout the economic cycle; it isn't true that a rise in production or income should always result in an increase in investment that is multiple of that amount.

This is due to the fact that one will try to employ existing machinery before purchasing any new ones if it's already sitting idle. Furthermore, instead of building a new facility, business owners would strive to fulfill the demand by overworking the current machinery if they anticipate that the boost in demand brought on by a surge in income or output will only be a transitory/temporary one. As a result, the accelerator theory assumes that there is no excess/surplus capacity in the industries of consumer goods.

In other words, it has been assumed that there are not any idle machines and that no additional shift work is feasible. If there was a surplus of capacity and additional shift work was feasible, the supply of commodities could have been increased using the current machinery, and the accelerator wouldn't have been necessary. Furthermore, the acceleration concept also makes the assumption that there is excess production capacity in the capital goods industries. If there is no extra capacity in the machine-making industries, increased demand for machines generated by the need for additional output will not result in an increase in machine supply.

Investment can't increase in the short term if there is no supply of machinery. The accelerator theory, therefore, assumes that the machine-making industry may, at least temporarily, increase its output. The supply can be boosted by working more shifts, cutting back on finished machine inventories, and other methods. Yet, stocks cannot be lowered below zero, and working extra hours or implementing additional initiatives has proven to be costly. Business owners won't think it worthwhile to boost investment in industries that make machines until demand has steadily climbed.

The accelerator does not have a constant size throughout the period. The worth of it will depend on the business people's calculation of how profitable it would be to build additional manufacturing facilities to produce more machines based on their expected operational lifespan. It's also assumed that demand for machines will stay stable in the future, despite the abrupt spike in demand.

Despite the limitations of the acceleration principle mentioned above, it highlights a significant force that generates economic swings. The combination of an accelerator and a multiplier, according to some economists, offers a sufficient and appropriate explanation for the business cycles that occur in free market economies.