The accelerator effect

The accelerator effect relates to the effect of a change in national income, (GDP) on the amount of investment that takes place in an economy. While the accelerator effect relates to the rate of change of national income and how this influences investment decisions, looked at more closely, it is the linkage between household spending and investment that is explored in the accelerator model.

For example, a small change in the rate of growth of national income (triggered by an increase in household spending), say by 0.5%, from 1.5% to 2%, could trigger an increase in net investment, from $200bn to $250bn (up by 25%). This increase is caused by a number of fundamental factors related to capital investment.

Factors effecting the accelerator

Firstly, decisions to invest by firms are long term and are sacrifice in that funds allocated to investment could be used elsewhere - either on 'current' expenditure on wages or raw materials, or they could be distributed to shareholders as dividends. This means that expenditure on capital equipment may be greater than short term change in national income warrants. For example, it is possible that, coming out of a recession with growth rates at just 1 or 2%, many firms may increase their capital expenditure by 20%. When this is multiplied across the economy, net investment may rise by more than the initial increase in national income.

Secondly, capital equipment is, by its nature, indivisible. This means that capital equipment, such as plant and machinery, cannot be broken down into smaller quantities - no car producer would slowly re-equip its production line piecemeal, with just one machine added each year, for eight years. Rather, it makes most sense either to purchase or develop a whole new plant over, say, a two year period. Indeed, it makes sense to invest in the largest scale possible to gain from economies of scale.

In addition there is are likely to be some significant information gaps - decisions to engage in capital expenditure (capex) invest are undertaken without perfect knowledge (of how demand will change in the future, and how regarding how effective their investment programme will be.) This uncertainty means that only when business optimism reaches a certain threshold will capex decisions be made.

Finally, as research indicates1, investment decisions are expensive and irreversible, and firms may often prefer to adopt a wait and see attitude.

If we combine these two factors it is clear to see that capital spending undertaken by firms is much more volatile than spending by households.

Constraints on the accelerator

For the accelerator effect to arise, certain conditions must be met, including:

The economy must be near to full capacity. If firms are operating with spare capacity, increases in national income (or household spending) are likely to be met by using existing capital equipment - hence output can be increased by applying more variable factors of production, such as labour, to the existing (under-utilised) machinery.

However, capital goods producers must be able to meet the demand for machinery and new technology. If they are also working at full capacity, then the price of capital goods will be driven up, making it less likely there will be a strong accelerator effect across the rest of the economy.

1. Arestis et al, 2016, Economic Modelling.pdf, Revisiting the accelerator principle in a world of uncertainty: Some empirical evidence, viewed March 10th 2021, https://www.repository.cam.ac.uk/bitstream/handle/1810/254525/Arestis%20et%20al%202016%20Economic%20Modelling.pdf?sequence=1 


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