Short notes on accelerator theory

 

This states that the investment varies with the rate of change of income rather than the rate of interest. This makes investment more volatile if output increase by 2% this can increase the amount of investment by 10%. When there is an increase in orders firms will have to invest in new production capacity.

This induced investment depends on changes in income

I = a (change in) Y

The size of a will depend upon the country’s capital/ output ratio. This is the cost of extra capital required to produce an increase in national output. E.g. if £2 million investment is required to produce £1million extra output. The capital/ output ratio is 2

Conclusions of the accelerator

  • investment will rise when there is a growth in the rate of national income
  • investment will be constant when the growth rate is the same
  • investment will decline if there is a fall in the growth rate

However

  • Many firms have spare capacity they can use without investing
  • Expectations are also important
  • Firms may make investment plans a long time in the future and may not be able to change them

Multiplier/ accelerator interaction

An increase in national income will set off the accelerator affect, but the increase in investment mat lead to a multiplier effect. This will lead to an exploding rise in national income. However there are limitations to the multiplier such as spare capacity

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By on November 28th, 2012 in