Accelerator effect
Encyclopedia
The accelerator effect in economics refers to a positive effect on private fixed investment
of the growth of the market economy (measured e.g. by a change in Gross National Product). Rising GNP (an economic boom or prosperity) implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity. This usually implies that profit expectations and business confidence rise, encouraging businesses to build more factories and other buildings and to install more machinery. (This expenditure is called fixed investment.) This may lead to further growth of the economy through the stimulation of consumer incomes and purchases, i.e., via the multiplier
effect.
The accelerator effect also goes the other way: falling GNP (a recession
) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages fixed investment, worsening a recession by the multiplier effect.
The accelerator effect fits the behavior of an economy best when either the economy is moving away from full employment
or when it is already below that level of production. This is because high levels of aggregate demand
hit against the limits set by the existing labor force, the existing stock of capital goods, the availability of natural resources, and the technical ability of an economy to convert inputs into products.
and working capital
), and the investment decision determines the change of capital stock in a sequences of periods, the acceleration effect emerges as only the current period gap affects the current investment, so do the previous gaps. The Aftalion-Clark accelerator v has such a form
, while the Keynesian multiplier m has such a form
where c is the propensity to consume.
From the above, it can clearly be seen that the change of investment has a multiplier effect on income, but the point that the increase of income accelerates capital accumulation
(the acceleration effect
increase over time) can only be shown numerically.
of capital goods (K) is proportional to the level of production (Y):
This implies that if k (the capital-output ratio) is constant, an increase in Y requires an increase in K. That is, net investment, In equals:
Suppose that k = 2 (usually, k is assumed to be in (0,1)). This equation implies that if Y rises by 10, then net investment will equal 10×2 = 20, as suggested by the accelerator effect. If Y then rises by only 5, the equation implies that the level of investment will be 5×2 = 10. This means that the simple accelerator model implies that fixed investment will fall if the growth of production slows. An actual fall in production is not needed to cause investment to fall. However, such a fall in output will result if slowing growth of production causes investment to fall, since that reduces aggregate demand
. Thus, the simple accelerator model implies an endogenous
explanation of the business-cycle
downturn, the transition to a recession.
Modern economists have described the accelerator effect in terms of the more sophisticated flexible accelerator model of investment. Businesses are described as engaging in net investment
in fixed capital goods in order to close the gap between the desired stock
of capital goods (Kd) and the existing stock of capital goods left over from the past (K-1):
where x is a coefficient representing the speed of adjustment (1 ≥ x ≥ 0).
The desired stock of capital goods is determined by such variables as the expected profit rate
, the expected level of output, the interest rate (the cost of finance), and technology. Because the expected level of output plays a role, this model exhibits behavior described by the accelerator effect but less extreme than that of the simple accelerator. Because the existing capital stock grows over time due to past net investment, a slowing of the growth of output (GDP) can cause the gap between the desired K and the existing K to narrow, close, or even become negative, causing current net investment to fall.
Obviously, ceteris paribus
, an actual fall in output depresses the desired stock of capital goods and thus net investment. Similarly, a rise in output causes a rise in investment. Finally, if the desired capital stock is less than the actual stock, then net investment may be depressed for a long time.
In the Neoclassical accelerator model of Dale Jorgenson, the desired capital stock is derived from the aggregate production function
assuming profit maximization and perfect competition
. In Jorgenson's original model(1963), there is no acceleration effect, since the investment is instantaneous, so the capital stock can jump.
Fixed investment
Fixed investment in economics refers to investment in fixed capital, i.e., tangible capital goods , or to the replacement of depreciated capital goods which have been scrapped....
of the growth of the market economy (measured e.g. by a change in Gross National Product). Rising GNP (an economic boom or prosperity) implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity. This usually implies that profit expectations and business confidence rise, encouraging businesses to build more factories and other buildings and to install more machinery. (This expenditure is called fixed investment.) This may lead to further growth of the economy through the stimulation of consumer incomes and purchases, i.e., via the multiplier
Multiplier (economics)
In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...
effect.
The accelerator effect also goes the other way: falling GNP (a recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages fixed investment, worsening a recession by the multiplier effect.
The accelerator effect fits the behavior of an economy best when either the economy is moving away from full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
or when it is already below that level of production. This is because high levels of aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
hit against the limits set by the existing labor force, the existing stock of capital goods, the availability of natural resources, and the technical ability of an economy to convert inputs into products.
Multiplier effect vs. acceleration effect
The acceleration effect is the phenomenon that a variable moves toward its desired value faster and faster with respect to time. Usually, the variable is the capital stock. In Keynesian models, fixed capital is not in consideration, so the accelerator coefficient becomes the reciprocal of the multiplier and the capital decision degenerates to investment decision. In more general theory, where the capital decision determines the desired level of capital stock (which includes fixed capitalFixed capital
Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...
and working capital
Working capital
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is...
), and the investment decision determines the change of capital stock in a sequences of periods, the acceleration effect emerges as only the current period gap affects the current investment, so do the previous gaps. The Aftalion-Clark accelerator v has such a form
, while the Keynesian multiplier m has such a form where c is the propensity to consume.From the above, it can clearly be seen that the change of investment has a multiplier effect on income, but the point that the increase of income accelerates capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
(the acceleration effect
increase over time) can only be shown numerically.Business Cycles vs. Acceleration effect
As the acceleration effect dictates that the increase of income accelerates capital accumulation, and the decrease of income accelerates capital depletion (in a simple model), this might cause the system unstable or cyclical, and hence many kinds of business cycle models are of this kind (the multiplier-accelerator cycle models).Accelerator models
The accelerator effect is shown in the simple accelerator model. This model assumes that the stockStock and flow
Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...
of capital goods (K) is proportional to the level of production (Y):
-
- K = k×Y
This implies that if k (the capital-output ratio) is constant, an increase in Y requires an increase in K. That is, net investment, In equals:
-
- In = k×ΔY
Suppose that k = 2 (usually, k is assumed to be in (0,1)). This equation implies that if Y rises by 10, then net investment will equal 10×2 = 20, as suggested by the accelerator effect. If Y then rises by only 5, the equation implies that the level of investment will be 5×2 = 10. This means that the simple accelerator model implies that fixed investment will fall if the growth of production slows. An actual fall in production is not needed to cause investment to fall. However, such a fall in output will result if slowing growth of production causes investment to fall, since that reduces aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
. Thus, the simple accelerator model implies an endogenous
Endogenous
Endogenous substances are those that originate from within an organism, tissue, or cell. Endogenous retroviruses are caused by ancient infections of germ cells in humans, mammals and other vertebrates...
explanation of the business-cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
downturn, the transition to a recession.
Modern economists have described the accelerator effect in terms of the more sophisticated flexible accelerator model of investment. Businesses are described as engaging in net investment
Net investment
In economics, net investment refers to an activity of spending which increases the availability of fixed capital goods or means of production. It is the total spending on new fixed investment minus replacement investment, which simply replaces depreciated capital goods....
in fixed capital goods in order to close the gap between the desired stock
Stock and flow
Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...
of capital goods (Kd) and the existing stock of capital goods left over from the past (K-1):
-
- In = x(Kd - K-1)
where x is a coefficient representing the speed of adjustment (1 ≥ x ≥ 0).
The desired stock of capital goods is determined by such variables as the expected profit rate
Rate of profit
In economics and finance, the profit rate is the relative profitability of an investment project, of a capitalist enterprise, or of the capitalist economy as a whole...
, the expected level of output, the interest rate (the cost of finance), and technology. Because the expected level of output plays a role, this model exhibits behavior described by the accelerator effect but less extreme than that of the simple accelerator. Because the existing capital stock grows over time due to past net investment, a slowing of the growth of output (GDP) can cause the gap between the desired K and the existing K to narrow, close, or even become negative, causing current net investment to fall.
Obviously, ceteris paribus
Ceteris paribus
or is a Latin phrase, literally translated as "with other things the same," or "all other things being equal or held constant." It is an example of an ablative absolute and is commonly rendered in English as "all other things being equal." A prediction, or a statement about causal or logical...
, an actual fall in output depresses the desired stock of capital goods and thus net investment. Similarly, a rise in output causes a rise in investment. Finally, if the desired capital stock is less than the actual stock, then net investment may be depressed for a long time.
In the Neoclassical accelerator model of Dale Jorgenson, the desired capital stock is derived from the aggregate production function
Production function
In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...
assuming profit maximization and perfect competition
Competition
Competition is a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources. It arises whenever two and only two strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same environment. For...
. In Jorgenson's original model(1963), there is no acceleration effect, since the investment is instantaneous, so the capital stock can jump.