The accelerator effect refers to the fact that an acceleration or deceleration of economic growth generates a positive or negative change in investment, respectively. This, in turn, can cause the economy to grow at an even higher or lower rate, depending on the case.
In other words, the accelerator effect refers to the relationship between the variation of the Gross Domestic Product (GDP) and investment. Thus, when the first increases or decreases, so does the second. But the impact does not stop there, rather the variation in investment affects GDP again.
To understand why this accelerating effect happens, we can pose the following. The economy is growing at a faster rate, and, consequently, companies receive greater demand from buyers (because they have seen their rents increase).
This causes companies to invest in capital goods to increase their production in order to meet demand.
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Consequently, as you have surely noticed, one of the components of GDP is increasing: private investment.
The same happens in the opposite direction. If the economy slows down, companies, anticipating that their sales will not increase, will only invest in replacing capital that has been depreciating or wearing out. In other words, it is not that they stop investing, but that they will invest what is necessary to produce the same amount.
We can point out some keys to the accelerating effect:
- It is a concept of the Keynesian models.
- For investment to accelerate, it is not enough for there to be economic growth (and not decrease), but it must increase at a faster rate. In other words, if the GDP shows a positive variation, for example, of 3% every year, this will not make companies invest in increasing their capital stock and their installed capacity.
- Investment does not have the change in GDP as its only explanatory variable. Other factors that can influence are, for example, the possibility of increasing another factor of production that is not capital (more workers can be hired instead of acquiring capital goods).
- It may be that the existing machinery has a longer useful life than expected, so it would not be necessary to increase the investment. This is another possible damper of the throttle effect.
Simple model of the accelerating effect
The accelerating effect can be represented in a model like the following:
In the above equation, In is net investment, k is the capital-output ratio, and Y is the level of output (GDP).
Net investment is the increase in capital (gross investment), but subtracting depreciation for the period. That is, it is the investment without considering what is necessary to replace the worn-out capital.
So, what this equation wants to tell us is that the net investment will vary as a function of the variation in production.
Suppose that production increases by 15 and that the ratio k is 1.5. So, the net investment would be: In=1.5*15=22.5.
Then, let us imagine that for the next period the economy speeds up and increases by 20. Thus, we have In=1.5*20=30.
It should be noted that the model presented is a simple version, but there are other more sophisticated models for the accelerator effect. For example, considering investment as a function of variations in GDP during various previous periods.