What is the 'Accelerator Theory'

The accelerator theory is an economic postulation that investments made by companies increase when either demand or income increases. The theory also suggests that when demand produces an excess of demand, companies can meet the need in two ways: decrease demand by raising prices or increase investment to the level of demand. The accelerator theory posits that companies typically choose to increase production, thereby increasing profits; this growth, in turn, attracts further investors that works to accelerate growth.

BREAKING DOWN 'Accelerator Theory'

The accelerator theory was conceived before Keynesian economics, but it came into public knowledge as the Keynesian theory began to dominate the general economic mindset of the 20th century. Developed by Thomas Nixon Carver and Albert Aftalion, among others, some critics argue against the accelerator theory because it removes all possibility of demand control through price controls. Empirical research, however, supports the theory's use.

This theory is generally interpreted to establish new economic policy. For example, the accelerator theory might be used to determine if using tax cuts to generate more disposable income for consumers – consumers who would then demand more products – would be preferable instead of giving the tax cuts to businesses that are then capable of utilizing the increased amount of capital for expansion and growth. Each government and its economists formulate an interpretation of the theory, as well as questions that the theory can help answer.

An Example of the Accelerator Theory

Consider an industry where demand is continuing to rise at a strong and rapid pace. Companies that are operating in this industry respond to this growth in demand by expanding production and also by more fully utilizing their existing capacity to produce. Some companies also seek to meet an increase in demand by selling down their existing inventory.

If there is a fairly clear indication or instinct that this higher level of demand will be sustained for a continued period of time, a company in this industry will likely opt to boost expenditures on capital goods – such as equipment, technology and/or factories – to further increase its production capacity. In this way, demand for capital goods is driven by a heightened demand for products being supplied by the company. This triggers the accelerator effect, which states that when there is a change in demand for consumer goods (an increase, in this case), there will be a higher percentage change in demand for capital goods.

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