Accelerator Principle of Investment

The accelerator principle states that a sustained increase in consumer demand can cause a proportionately larger increase in firms' demand for capital goods. Private induced investment therefore depends primarily on the change in expected output or sales, rather than merely on their existing level.

How the accelerator works

Firms require capital to produce output. If the desired capital stock bears a stable relationship to output, K_t = vY_t, then induced net investment is I_t = K_t - K_t-1 = v(Y_t - Y_t-1). Here, v is the capital-output ratio, also called the accelerator coefficient.

• When consumer demand raises expected sales, firms expand productive capacity by purchasing machinery, constructing facilities or adding equipment.
• The resulting investment may exceed the initial increase in demand because firms need several units of capital to produce an additional unit of annual output.

Implications for private investment

• It is rising demand, not simply a high level of demand, that generates positive induced net investment.
• If demand continues growing but its absolute increase becomes smaller, the rate of investment falls, even though output may still be rising.
• If demand stagnates, firms need no additional capital under the simple model; if it falls, desired capital may decline and produce negative net investment or disinvestment.
• Actual gross investment may remain positive because firms still replace depreciated capital.

Conditions and limitations

The simple accelerator is strongest when firms operate near capacity and regard increased demand as durable. Its predictions weaken when excess capacity, uncertain expectations, financing constraints or adjustment lags allow firms to meet demand without immediately expanding capital.

• The model assumes a broadly fixed capital-output ratio and available technology.
• Temporary consumption increases may not induce investment because firms base capacity decisions on expected future sales.
• Investment itself affects income and demand, so interaction between the multiplier and accelerator can amplify economic fluctuations.