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Accelerator

The acceleration principle states that a small increase in income leads to a greater increase in investment. When income rises, consumption and demand for consumer goods increases. To meet this increased demand, investment must rise to expand productive capacity. Initially, excess capacity is used, but higher profits induce entrepreneurs to invest in new plants and machinery. The accelerator effect is the relationship between income changes and investment changes - if demand rises by $1, a $3 increase in investment may occur. As shown in the example, a 60% rise in demand led to a 400% increase in gross investment, demonstrating the destabilizing role of the accelerator principle.

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44 views

Accelerator

The acceleration principle states that a small increase in income leads to a greater increase in investment. When income rises, consumption and demand for consumer goods increases. To meet this increased demand, investment must rise to expand productive capacity. Initially, excess capacity is used, but higher profits induce entrepreneurs to invest in new plants and machinery. The accelerator effect is the relationship between income changes and investment changes - if demand rises by $1, a $3 increase in investment may occur. As shown in the example, a 60% rise in demand led to a 400% increase in gross investment, demonstrating the destabilizing role of the accelerator principle.

Uploaded by

ஜெய் சந்தொஷ் நாராயனன்
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Acceleration Principle

According the principle of acceleration, when income of the people increases


their spending power increases. Hence their consumption expenditure
increases and consequently the demand for consumer goods increases. A
small increase in the demand for consumer goods is followed by a greater
increase in investment expenditure. In order to meet this enhanced demand,
investment must increase to raise the productive capacity of the community.
Initially, however, the increased demand will be met by over-working the
existing plants and machinery. All this leads to increase in profits which will
induce entrepreneurs to expand their plants by increasing their investments.
Thus a rise in income leads to a further induced investment. The accelerator
is the numerical value of the relation between an increase in income and the
resulting increase in investment.

Required
Demand Stock of Replacement Net Gross
Years
Rs Cost Rs Investment Investment
Capital Rs
5 machines 1 machine
2007 5lac 0 machine 3lac
15 lac 3lac
5 machines 1 machine
2008 5 lac 0 machine 3 lac
15lac 3lac
8 machines 1 machine 3 machines
2009 8 lac 12 lac
24 lac 3lac 9 lac
10 machines 1 machine 2 machines
2010 10 lac 9 lac
30 lac 3 lac 6 lac
10 machines 1 machine
2011 10 lac 0 machine 3 lac
30 lac 3 lac
8 machines 1 machine – 2 machines
2012 8 lac – 3 lac
24 lac 3 lac 6 lac
Cost per machine: Rs. 3 lac per machine

In the above example, suppose we are living in a world, where the only
commodity produced is cloth. Further suppose that to produce cloth Rs.
100,000, we require one machine worth Rs.3 lac, which means that the value
of the accelerator is 3 (i.e., the capital-output ratio is 1:3). That is, if
demand rises by Re.1 lac, additional investment worth Rs. 3 lac takes place.
If the existing level of demand for cloth remains constant, let us say, at Rs.5
lac , then to produce this much cloth we need five machines worth Rs. 15
lac. At the end of one year, let us suppose, that one machine becomes
useless as a result of wear and tear, so that at the end of one year, a gross
investment of Rs. 3 lac must take place to replace the old machine in order
that the stock of capital is capable of producing output worth Rs. 5 lac.

In the third period, i.e., the year 2009, demand rises to Rs.8 lac . To produce
output worth Rs. 8 lac, we need 8 machines. But our previous stock
consisted of only 5 machines. Thus if we are to produce output worth Rs. 8
lac, we must install 3 new machines, worth Rs. 9 lac. The net investment for
the year 2009 will be Rs. 9 lac and with the replacement cost of one machine
Rs. 3 lac, our gross investment jumps from Rs. 3 lac in the year 2008 to Rs.
12 lac in the year 2009. A 60 % increase in demand led to a 400 %
increase in gross investment. Here one can see a glimpse of the powerful
destabilising role of accelerator.

Likewise when there is fall of demand for cloth for Rs 2 lac , from Rs 10 lac
to Rs 8 lac, one can find a negative demand for a machine( Rs -3 lac). Thus
smaller changes in demand for consumer goods are followed by greater
changes in investments. Thus acceleration principles explain better than
multipler the swings in the economy.

Assumptions of the Accelerator:

This principle assumes that there is no excess capacity in the consumer


goods industries. In capital goods industries, it has been assumed that
there is an existence of surplus capacity. If there is no excess capacity in
capital goods industries, increased demand for machines could not lead to
increase in the supply of machines by their manufacturers. The machine-
making industry or capital goods industry must be capable of changing their
output level whenever desired. Acceleration coefficient does not remain
constant over time since its value will be affected by the businessmen’s
calculations regarding the profitability of installing new plants to make more
machines on the basis of their probable working life. The demand for
machines will remain stable in the future, although the increase in demand
has suddenly cropped up. The combined effects of investment multiplier
and acceleration are called super multiplier that saves the economy
from the clutches of depression.

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