**Definition of the Accelerator Effect**

The accelerator effect states that investment levels are related the rate of change of GDP. Thus an increase in the rate of economic growth will cause a correspondingly larger increase in the level of investment. But, a fall in the rate of economic growth will cause a fall in investment levels.

### Why the accelerator effect occurs

- If firms see a rise in demand and expect this demand to be maintained, then they will soon start to reach full capacity.
- Therefore, to meet the future demand, they will respond by investing now. To meet a growth in demand may require considerable investment outlay.
- Because of economies of scale in investment, it is more efficient to make a significant investment (e.g. increase capacity 20%) – rather than small annual increases in investment of 2%.
- Therefore, firms will wait for promising economic conditions, before embarking on investment decisions.

### Implications of the accelerator effect

UK economic growth and business investment 2009-2012

- Investment tends to be more volatile than economic growth
- 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.

### Example from the UK economy

UK economy 2008-15

**Limitations of the accelerator effect**

- Time lags in investment. Once a project is started, a firm will tend to want to complete it – even if demand slows down.
- Firms won’t respond to every minor change in demand and output. Investment requires planning and once started, can’t be easily stopped.
- Investment is affected by many other factors, such as investor confidence and the “animal spirits” of firms.
- It depends whether firms are optimistic about their industry. For example, a bookshop may be more nervous about investing in increasing capacity because they fear changing conditions. Whereas an online store may be more optimistic about the long-term future of their industry.

### 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*×Δ*Y*

- 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.

**Related**