UNDERSTANDING ACCELERATOR THEORY IN MACROECONOMICS

✓ Understanding Accelerator Theory

The accelerator theory was conceived by Thomas Nixon Carver and Albert Aftalion, among others, before Keynesian economics, but it came into public knowledge as the Keynesian theory began to dominate the field of economics in the 20th century. 

✓ The accelerator theory is an economic postulation whereby investment expenditure increases when either demand or income increases. The theory also suggests that when there is excess demand, companies can either decrease demand by raising prices or increase investment to meet the level of demand. The accelerator theory posits that companies typically choose to increase production, thereby increasing profits, to meet their fixed capital to output ratio.

✓ Fixed capital to output ratio states that if one (1) machine was needed to produce a hundred (100) units and demand rose to two hundred (200) units, then investment in another machine would be needed to meet this increase in demand. From a macro-policy point of view, the accelerator effect could act as a catalyst for the multiplier effect, though there is no direct correlation between these two.

Accelerator Theory Example

Consider an industry where demand is continuing to rise at a strong and rapid pace. Firms that are operating in this industry respond to this growth in demand by expanding production and also by fully utilizing their existing capacity to produce. Some companies also meet an increase in demand by selling down their existing inventory.
If there is a clear indication that this higher level of demand will be sustained for a long period, a company in an industry will likely opt to boost expenditures on capital goods—such as equipment, technology, and/or factories—to further increase its production capacity. Thus, demand for capital goods is driven by heightened demand for products being supplied by the company. This triggers the accelerator effect, which states that when there is a change in demand for consumer goods (an increase, in this case), there will be a higher percentage change in demand for capital goods.
An example of a positive accelerator effect is investment in wind turbines. Volatile oil and gas prices increase the demand for renewable energy. To meet this demand, investment in renewable energy sources and wind turbines increases. However, the dynamic can occur in reverse. If oil prices collapse, wind farm projects may be postponed, as renewable energy is economically less viable.

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https://www.investopedia.com/terms/a/acceleratortheory.asp#:~:text=The%20accelerator%20theory%20is%20an,either%20demand%20or%20income%20increases.&text=The%20accelerator%20theory%20posits%20that%20companies%20typically%20choose%20to%20increase,fixed%20capital%20to%20output%20ratio.

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