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

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