investment function - accelerator

ACCELERATOR

Introduction, Multiplier vs. Accelerator, Meaning of Accelerator, Rationale, Induced

Demand, Implications, Limitations, Multiplier & Accelerator distinguished & Leverage

Effect.

Introduction

The principle of acceleration of derived demand.

Multiplier and accelerator are parallel concepts.

But accelerator and multiplier principles explain opposite effects.

Multiplier

Effect of investment on aggregate income through consumption.

Dependence of consumption and income on investment.

Accelerator

Effect of change in consumption on investment.

Dependence of investment on consumption.

When income or consumption increases investment will increase by a multiple amount.

Definition of Accelerator

It measures the effect of an increment or decrease in the rate of consumption on the

volume of investment.

It is the ratio of the net change in investment to the net change in consumption. It is the

numerical value of the relation between the increase in investment due to an increase in

aggregate income – Δ I / Δ Y.

Rationale of the Accelerator

Increasing income and consumption requires increasing amounts of commodities have to be produced.

Increasing need for machinery and capital assets.

A derive demand increasing demand for consumption goods leads to increasing demand for capital goods.

Changes in investment in the capital goods industry is due to augmented income and demand in the consumer goods industry.

Induced Demand

Augmented demand in consumer goods industry induces investment in capital goods industries.

Accelerator measures changes in investment induced by augmented consumer goods demand.

Net induced investment positive if national income increases.

Net induced investment zero if national income remains constant.

Inference - 1

Increase in demand for consumption goods in the economy generally leads to an

accelerated demand for investment goods.

Implications

Helps to understand process of income generation in a clearer and a more scientific manner.

Multiplier explains one part and accelerator explains the other part of increase in income.

Explains why business fluctuations is more acute in investment goods industries than in consumer goods industries.

Limitations of the Accelerator - 1

No resultant new investment in capital goods industry in case of existent excess or idle machinery.

Assumes existence of surplus capacity in investment goods industries.

Producers of consumer goods should not feel that the rise in demand for their goods is only temporary.

Limitations of Accelerator - 2

All investments need not wait for changes in the rate of consumption.

Work of accelerator difficult if real and monetary resources for investment good industries are not easily available.

Assumes constant ratio between output of consumer goods and investment goods which is not always constant due to improved production methods or intensive factor use or change in entrepreneurial expectations.

Multiplier – Accelerator Distinguished

Multiplier

1. Effect of change in investment on income & employment.

2. Consumption dependant on investment.

3. Depend on marginal propensity to consumer.

4. Depends upon psychological factors.

Accelerator

1. Effect of change in consumption on investment.

2. Investment dependant on consumption.

3. Depends on the durability of machines.

4. Depends upon technological factors.

Multiplier – Accelerator Interaction - 1

Prof. Hansen combines the working of the multiplier and accelerator thereby showing the mutual relation between investment and consumption.

Two effects of growth in primary or autonomous investment: (a) higher employment and income; (b) higher demand for articles of personal consumption (the Multiplier).

Multiplier – Accelerator Interaction - 2

Subsequent increase in investment to satisfy rise in demand for consumer goods (the Accelerator).

Induced investment activates the multiplier leads to increase in employment and income which in turn induces new investment – LEVERAGE EFFECT.

Reason for combining multiplier – accelerator principle is to demonstrate mutual dependence of investment and consumption in a full manner.