Accelerator theory

From WikiTextbook

The accelerator is based on an assumption of a stable or fixed capital to output ratio. It all depends on the demand for something. for example; if demand is higher than the current capacity of a company, they may think about expanding and building new plants/factories and/or buying more machionery to help cope with the heavier demand. Therefore, depends on the rate of national income. A slow down in demand would perhaps put a halt on capital investment.

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 gross domestic product). Rising GDP (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.

The accelerator effect also goes the other way: falling GDP (a recession) hurts business profits, sales, cash flow, use of capacity, and expectations. This in turn discourages fixed investment, making a recession worse (especially when the multiplier effect is remembered).

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