The accelerator effect examines the effect on levels of investment from a change in economic output (or demand for a product).
The simple accelerator model suggests that capital investment is a function of output. If there is an increase in demand and economic output, investment will rise to meet the expected demand.
The simple accelerator model suggests that a fall in the growth rate can lead to lower investment. This suggests the accelerator effect can explain how an economic slowdown leads to a recession.
- A fall in growth rate leads to lower investment. Investment is a component of AD, therefore AD falls further.
The accelerator model suggests the business cycle can be volatile.
Formula for Accelerator Effect
K = f(Y) K = Capital Stock
Y= National Output
f = relationship between capital and output.
Example of Accelerator Effect
- Assume f=2.
- If Y increases by £15bn. Then investment will need to be £30bn (15*2)
- If in the next year Y increases by £5bn, then investment will be only £10bn.
This suggests there will be a fall in the level of net investment. Therefore a fall in the growth rate in the economy can lead to lower investment and further downward pressure on the economy.
Accelerator Effect and Real World
In the real world, there are many other variables that influence investment levels apart from output (and demand). Firms will also take into account interest rates, state of technology, expectations of future, confidence. There are also time lags in investment. Also, it can be difficult to get accurate statistics about the state of demand.
Therefore, a fall in the rate of economic growth doesn’t necessarily lead to a fall in investment. However, empirical evidence suggests the level of investment does tend to be more volatile than the level of economic growth. It is one factor that creates a more volatile business cycle.
UK economy 2008-15
Business investment. 2005-2015. The slowdown and then fall in economic growth in 2008, led to sharp fall in business investment.
Negative accelerator effect
If there is a fall in the growth of demand, then net investment will fall as firms cut back on starting new investment projects.
Micro Example of Accelerator Effect
A firm will invest depending on demand for its products. The rise in demand for iPads will cause Apple to be investing in increasing capacity to meet future demand. If the iPad drops out of fashion, Apple could be left with a lot of spare capacity and so would cut back investment drastically.
Accelerator Effect and Multiplier Effect
There is some relationship between the two. But, it is important to understand they are different concepts. The multiplier effect states a rise or falls in injections into the economy (for example investment) may cause a bigger final increase (or fall in GDP).