Revision: Accelerator

This revision note looks at the accelerator. Put simply, the accelerator model suggests a positive relationship between spending on new capital investment and the rate of growth of demand or output.

Accelerator theories of investment assume that there is a desired capital stock for a given level of output and interest rates. A rise in output or a fall in interest rates may prompt increased levels of investment as businesses adjust to reach the new optimal capital stock level. Equally during a slowdown or recession, expected demand tails away and many businesses may choose to curtail capital projects until economic conditions improve. Thus in a recession we see evidence of a negative accelerator effect which in turn leads to a contraction in output and profits in those industries that build, design and install new capital equipment and buildings.

The accelerator model works on the basis of a fixed capital to output ratio. For example if demand in a given year rises by £4 million and each extra £1 of output requires an average of £3 of capital inputs to produce this output, then the net level of investment required will be £12 million.

One criticism of this simple accelerator model is that the capital stock of a business can rarely be adjusted immediately to its desired level because of ‘adjustment costs’ and ‘time lags’. The adjustment costs include the cost of lost business due to installation of new equipment or the financial cost of re-training workers. Firms will usually make progress towards achieving an optimum capital stock rather than moving smoothly from one optimal size of plant and machinery to another.

A further criticism of the basic accelerator model is that it ignores the spare capacity that a business might have at their disposal and also their ability to outsource production to other businesses to meet a short term rise in demand.

For example in the latter stages of a recession, most businesses are operating well below their capacity limits, in technical terms, their capacity utilisation is low. So if demand then picks up in the recovery phase of the cycle, they can simply make more intensive use of existing capacity. Investment spending is likely to pick up strongly towards the latter stages of an economic cycle – the risk being that fresh supply becomes available just at the time when demand is tailing off.

A full set of AS macro revision notes is available here and our AS economics revision presentations can be found here