Definition of the Accelerator Effect: The accelerator effect states that investment levels are related the rate of change of GDP. Thus an increase the rate of economic growth will have a corresponding larger increase in the level of investment. However, a fall in the rate of GDP growth could lead to lower investment levels.
The accelerator model attempts to explain the volatility of investment that we see.
Simple Accelerator Model
This model assumes that the stock of capital goods (k) is relative to Y
- K = k×Y
- If we assume that the capital output ratio (k) is constant. An increase in Y requires an increase in K.
Net investment, In therefore equals:
- In = k×ΔY
- Suppose that k = 2
- This equation implies that if Y rises by 20, then net investment will equal 20×2 = 40, as suggested by the accelerator effect.
- If Y then rises by only 10, the equation implies that the level of investment will be 10×2 = 20.
This implies that a slowdown in the growth of Y can lead to lower fixed investment.
- However, in the next year, if Y rises by 15, then the level of investment will be 15*2 = 30.
Therefore, with an increase in the growth of Y, we get a big increase in investment.
Implications of the Accelerator Effect
UK economic growth and business investment 2009-2012
- Investment tends to be more volatile than economic growth
- If the rate of economic growth stays the same, investment levels will also stay the same
- Investment spending can fall even when GDP is rising. This is because if there is a fall in the rate of economic growth firms may invest less.
- If GDP falls, investment spending can fall very significantly.
- Accelerator Coefficient. This is the level of induced investment as a proportion of a rise in National income accelerator coefficient = Investment / change in Income
Limitations of the Accelerator Effect
Investment is affected by several factors other the rate of change of GDP. Investment can be influenced by:
- Interest rates
- Confidence ‘animal spirits’
- technological change
- Time lags. Firms won’t respond to every minor change in demand and output. Investment requires planning and once started, can’t be easily stopped.