The Accelerator Effect

Key Terms

Accelerator: The accelerator effect is defined as the effect positive market economic growth has on private fixed income, for example, through changes in real output.

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What is the Accelerator?

The accelerator effect is a notion which believes that determinants of the level of investment is a change in demand. As demand increases or there is an expected increase in demand (perhaps coming out of a recession) firms may need/or wish to expand capacity hence they may invest in new factories, technology etc. Additionally, some investment may be needed for physical depreciation of machinery and tools all this then leads to the accelerator effect kicking in as firms expect the change in demand and need more capital to meet the projected future demand.

The accelerator effect interacts with the multiplier if there is an increase in aggregate demand due to the multiplier the accelerator will further support this creating a further increase in investment and hence output (as investment is a form of supply side-policy). However, the same could happen when there is a fall in the level output, as investment slows, which further leads to a fall in investment creating a negative multiplier effect. The interaction of the multiplier and accelerator can result in cyclical fluctuations in the level of output, this can be seen through the multiplier-accelerator model also known as Hansen-Samuelson Model (however you do not need to know this for the A-Level Specification).

The Accelerator and its Impact on Aggregate Supply/Demand

The accelerator effect has a positive impact on the economy as firm increase investment expenditure the productive capacity of the economy increases (hence real output (GDP) increase). This is because the level of full employment shifts in the long run as investment is a type of supply side policy.

(Let’s look at a Neo-Classical graph depicting the accelerator effect, as we can see we have a long-run aggregate supply curve (LRAS1), and we have the economy starting at an equilibrium where Real GDP is at Y0 – Full Employment and the price is P0. From this point on we assume firms anticipate the increase in demand, and start investing in order to increase their capacity, hence the increase in in aggregate demand from AD0 to AD1. This causes a movement along the short-run aggregate supply curve to the new price of P1 and Real GDP output of Y1. However, the long run effects of the increase in investment will lead to a shift of the long-run aggregate supply curve (LRAS1 to LRAS2) therefore a new equilibrium level of full employment is established. It is worth to note that if firms settle at the new equilibrium and stop further investment it may put the accelerator effect into reverse.)

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The Multiplier, Accelerator Effect and Output Gaps - Madex Economics

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Sources/Further Reading:

The Accelerator Effect - https://en.wikipedia.org/wiki/Accelerator_effect#:~:text=In%20economics%2C%20the%20acceleration%20effect,total%20change%20in%20domestic%20output.&text=It%20also%20entices%20firms%20to,spending%20known%20as%20fixed%20investment