What is the 'Accelerator Theory'?

The accelerator theory is an economic postulation whereby companies' investments increase when either demand or income increases. The theory also suggests that when there is an excess of demand, companies can meet the demand in two ways; either decrease demand by raising prices or increase investment to meet the level of demand. The accelerator theory posits that companies typically choose to increase production, thereby increasing profits. This growth, in turn, attracts additional investors who also 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 field of economics in 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.

This theory is typically interpreted to establish new economic policy. For example, the accelerator theory might be used to determine if introducing tax cuts to generate more disposable income for consumers – consumers who would then demand more products – would be preferable to tax cuts for businesses, which could use the additional 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 fully utilizing their existing capacity to produce. Some companies also meet an increase in demand by selling down their existing inventory.

If there is a clear indication that this higher level of demand will be sustained for a long period, a company in an industry will likely opt to boost expenditures on capital goods – such as equipment, technology and/or factories – to further increase its production capacity. Thus, demand for capital goods is driven by 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.

An example of a positive accelerator effect is investment in wind turbines. Volatile oil and gas prices increase the demand for renewable energy. To meet this demand, investment in renewable energy sources and wind turbines increases. However, the dynamic can occur in reverse. If oil prices collapse collapse, wind farm projects may be postponed renewable energy is economically less viable

RELATED TERMS
  1. New Growth Theory

    New growth theory is a concept that presumes the desire and wants ...
  2. Biased Expectations Theory

    The biased expectations theory is a theory that the future value ...
  3. Accounting Theory

    Accounting theory is the field of assumptions, methodologies ...
  4. Mechanism Design Theory

    Mechanism design theory is an economic theory that seeks to study ...
  5. Residual Equity Theory

    Residual equity theory assumes common shareholders to be the ...
  6. Odd Lot Theory

    The odd lot theory is a technical analysis theory based on the ...
Related Articles
  1. Investing

    Interest Rate Predictions With Expectations Theory

    The expectations theory uses long-term interest rates to predict future short-term interest rates.
  2. Investing

    Oil As An Asset: Hotelling's Theory On Price

    Not sure where oil prices are headed? This theory provides some insight.
  3. Insights

    Introduction to Supply and Demand

    Learn about one of the most fundamental concepts of economics - supply and demand - and how it relates to your daily purchases.
  4. Small Business

    5 Tips for Getting Into a Startup Accelerator

    Getting into a startup accelerator is extremely competitive, but these five tips can help.
  5. Investing

    Nobel Winners Are Economic Prizes

    Before you try to profit from their theories, you should learn about the creators themselves.
  6. Investing

    The Evolution of ETFs

    Key 20th-century financial theories changed the way investors viewed markets and created the circumstances in which ETFs could emerge.
RELATED FAQS
  1. What are the differences between weak, strong and semi-strong versions of the Efficient ...

    Discover how the efficient market theory is broken down into three versions, the hallmarks of each and the anomalies that ... Read Answer >>
  2. Does the tradeoff model or the pecking order play a greater role in capital budgeting?

    Understand the difference between the trade-off theory and the pecking order theory, and learn what these theories tell companies ... Read Answer >>
  3. How Does the Law of Supply and Demand Affect Prices?

    Learn how the law of supply and demand affects prices, as when one outweighs the other, prices can rise or fall in response. Read Answer >>
  4. How do I negotiate a lower annual percentage rate (APR) with my credit card company?

    Discover the main factors of economic policy that, according to Keynesian economic theory, drive the marginal propensity ... Read Answer >>
  5. Has the Efficient Market Hypothesis been proven correct or incorrect?

    Explore the efficient market hypothesis and understand the extent to which this theory and its conclusions are correct or ... Read Answer >>
  6. How does the law of supply and demand affect the housing market?

    Learn about the law of supply and demand, the relationship between supply and demand, and how it affects the housing market. Read Answer >>
Trading Center