Accelerator

What Is Accelerator?

The accelerator principle is a concept within Economic Theory that describes how changes in aggregate demand for consumer goods can lead to a magnified, proportional change in Investment in capital goods. At its core, the accelerator mechanism explains that businesses invest in new plant and equipment not merely based on the level of demand, but on the rate of change of demand. If consumer demand is stable, firms only need to replace depreciated capital. However, if demand is increasing, businesses may need to expand their Capacity Utilization by acquiring new Fixed Capital, leading to a surge in investment. Conversely, a slowdown or decrease in consumer demand can cause a sharp reduction in new investment, as existing capital may become underutilized. This interplay contributes to the cyclical nature of economies.

History and Origin

The foundational ideas behind the accelerator principle emerged in the early 20th century. Economists such as Thomas Nixon Carver (1903), Albert Aftalion (1909), and C.F. Bickerdike (1914) independently explored aspects of this relationship. However, it was John Maurice Clark who is widely credited with the systematic development of the simple accelerator model in 1917, particularly in his work Studies in the Economics of Overhead Costs (1923).⁹ Clark's contribution highlighted how fluctuations in consumer demand, especially when existing productive capacity is exhausted, could severely impact investment demand.⁸ The accelerator theory gained significant prominence and integration into macroeconomic thought, especially with the rise of Keynesian economics, as it provided a robust explanation for the volatility of investment and its role in Business Cycles.⁷

Key Takeaways

• The accelerator principle posits that investment levels respond to the rate of change in output or demand, rather than the absolute level.
• A small change in consumer demand can induce a proportionally larger change in business investment in capital goods.
• This principle helps explain the amplification of economic swings, contributing to both Economic Growth during booms and sharper contractions during Recession periods.
• It assumes a stable capital-output ratio and that businesses aim to maintain this ratio to meet changing demand.
• The accelerator interacts with other economic phenomena, such as the multiplier effect, to influence overall economic activity.

Formula and Calculation

The basic accelerator principle can be expressed as a relationship between induced investment and the change in output or consumption. While often conceptual, a simplified representation can be given by:

$I_t = v (Y_t - Y_{t-1})$

Where:

• (I_t) = Induced Net Investment in period (t)
• (v) = The accelerator coefficient (capital-output ratio)
• (Y_t) = Output or Income (e.g., Gross Domestic Product) in period (t)
• (Y_{t-1}) = Output or Income in the previous period ((t-1))

The accelerator coefficient (v) represents the amount of new Capital Stock required to produce one additional unit of output. This formula implies that if output increases, new investment is needed to expand productive capacity.

Interpreting the Accelerator

Interpreting the accelerator principle involves understanding its implications for business behavior and the broader economy. A high accelerator coefficient indicates that a given change in demand will trigger a substantial change in investment, suggesting a more volatile economy. When output or consumer demand rises, businesses aim to maintain their desired capital-to-output ratio. If they are already operating near full capacity, even a modest increase in demand necessitates new investment in machinery, factories, and other capital goods. This induced investment further stimulates the economy.

Conversely, if demand growth slows or declines, firms may find themselves with excess capacity. In such a scenario, new investment can plummet, as businesses postpone or cancel expansion plans and simply rely on existing capital until demand recovers. This can exacerbate economic downturns. The accelerator helps to illustrate why investment, a key component of Aggregate Demand, tends to be more volatile than other components like Consumption.

Hypothetical Example

Consider a hypothetical economy with a clothing manufacturing sector. Initially, the sector produces 1,000,000 units of clothing per year, utilizing its existing machinery. Assume the accelerator coefficient (v) for this sector is 3, meaning that for every $1 increase in output, $3 of new capital investment is required to maintain the desired capital-output ratio.

In Year 1, consumer demand for clothing increases, leading to the sector producing 1,100,000 units, an increase of 100,000 units.
According to the accelerator principle, the induced net investment in Year 1 would be:
$I_1 = v \times (Y_1 - Y_0)$
$I_1 = 3 \times (1,100,000 - 1,000,000)$
$I_1 = 3 \times 100,000$
$I_1 = 300,000$
The sector invests $300,000 in new machinery and equipment to meet the increased demand. This new Investment stimulates further economic activity.

Now, imagine in Year 2, the demand growth slows, with output increasing only to 1,120,000 units, an increase of 20,000 units from Year 1.
The induced net investment in Year 2 would be:
$I_2 = 3 \times (1,120,000 - 1,100,000)$
$I_2 = 3 \times 20,000$
$I_2 = 60,000$
Even though output is still growing, the rate of growth has slowed, leading to a significant drop in new investment from $300,000 to $60,000. This example illustrates how changes in the rate of demand can have a disproportionately large impact on investment.

Practical Applications

The accelerator principle has several practical applications in economics and financial analysis. It is a fundamental component in understanding and forecasting economic fluctuations.

• Business Investment Decisions: Businesses often use similar logic, albeit with more complex models, to determine capital expenditure. When consumer spending is robust and rising, companies might ramp up plans for expansion, leading to increased demand for capital goods. Conversely, a weakening outlook for Gross Domestic Product growth can quickly freeze corporate investment. Official data on GDP and Investment can be found through resources like the Federal Reserve Economic Data (FRED) system.⁶
• Economic Forecasting: Economists use the accelerator principle to predict shifts in investment spending, which is a highly volatile but crucial component of economic activity. Understanding this dynamic helps in forecasting periods of rapid Economic Growth or potential downturns.
• Policy Formulation: Policymakers consider the accelerator when formulating Fiscal Policy and Monetary Policy. For instance, stimulus measures aimed at boosting consumer demand might be expected to have an amplified effect on business investment.

Limitations and Criticisms

While a powerful explanatory tool, the accelerator principle has several limitations and has faced criticism:

• Constant Capital-Output Ratio Assumption: The basic model assumes a fixed capital-output ratio, meaning that a certain amount of capital is always required to produce a given amount of output. In reality, this ratio can change due to technological advancements, shifts in production processes, or changes in capacity utilization.⁵
• Excess Capacity: The principle assumes no significant excess capacity exists in industries. If firms already have idle machinery or can introduce extra shifts, they may not need to invest in new capital even if demand increases.⁴ The accelerator effect only fully kicks in when existing capacity is stretched.
• Neglect of Expectations and Profitability: The naive accelerator largely overlooks the role of business expectations about future demand, Interest Rates, and profitability. Investment decisions are forward-looking and influenced by confidence, credit availability, and long-term outlook, not just immediate past changes in demand.³
• Time Lags: The model often simplifies or ignores the time lags between a change in demand, the decision to invest, and the actual implementation of new capital projects.² Investment projects can take months or years to complete, during which demand conditions may change again.
• Supply Elasticity: It assumes that the supply of capital goods and the necessary factors of production (like labor and raw materials) are perfectly elastic. If capital goods industries cannot easily increase their output, the accelerator mechanism may be constrained.

These limitations mean that while the accelerator provides a useful framework, its real-world application requires considering other economic factors.¹

Accelerator vs. Multiplier

The accelerator principle and the Multiplier effect are two distinct but interconnected concepts in macroeconomics that help explain economic fluctuations. Both describe how an initial change in spending can lead to larger changes in economic activity, but they focus on different aspects:

Often, the two principles are combined in economic models (known as the multiplier-accelerator model) to provide a more comprehensive explanation of Business Cycles. An initial increase in investment (multiplier effect) leads to higher income, which then stimulates consumption. This increased consumption, in turn, can induce further investment (accelerator effect), creating a feedback loop that amplifies economic booms and busts.

FAQs

What is the primary idea behind the accelerator principle?

The primary idea behind the accelerator principle is that business investment in new capital goods is highly sensitive to the rate of change in consumer demand or overall economic output. Even a small increase in demand, if sustained, can trigger a much larger increase in investment.

How does the accelerator differ from startup accelerators?

In finance, the term "accelerator" can also refer to a type of organization (startup accelerator) that provides mentorship, resources, and seed funding to early-stage companies. This is distinct from the accelerator principle in Economic Theory, which describes a macroeconomic relationship between changes in demand and investment levels within the broader economy.

Why is investment so volatile according to the accelerator?

Investment is volatile because firms respond to changes in demand. If demand is growing rapidly, they need significant new capital. If demand growth slows or declines, the need for new capital can vanish or even reverse, as existing capital becomes sufficient or excessive. This amplifies the swings in investment compared to consumption.

Does the accelerator principle always hold true?

No, the accelerator principle has limitations. It works best when there is little to no Capacity Utilization in existing facilities and when firms are confident that changes in demand are permanent. Factors like excess capacity, time lags in investment projects, and changing expectations can temper its effects in the real world.

How does the accelerator influence business cycles?

The accelerator principle plays a key role in amplifying Business Cycles. During an economic expansion, rising demand leads to accelerating investment, which further fuels growth. Conversely, during a downturn, falling demand leads to a sharp reduction in investment, intensifying the contraction. This feedback loop can make economic swings more pronounced.