Accelerator Theory: Overview and Examples

What Is the Accelerator Theory?

The accelerator theory, a key concept of Keynesian economics, stipulates that capital investment outlay is a function of output. For example, an increase in national income, as measured by the gross domestic product (GDP), would see a proportional increase in capital investment spending.

Understanding the Accelerator Theory

The accelerator theory is an economic postulation whereby investment expenditure increases when either demand or income increases. The theory also suggests that when there is excess demand, companies can either decrease demand by raising prices or increase investment to meet the level of demand.

The accelerator theory posits that companies typically increase production, thereby increasing profits, to meet their fixed capital–to-output ratio.

The fixed capital–to-output ratio states that if one machine was needed to produce 100 units and demand rose to 200 units, then investment in another machine would be needed to meet this increase in demand. From a macro-policy point of view, the accelerator effect could act as a catalyst for the multiplier effect, though there is no direct correlation between these two.

The accelerator theory was conceived by Thomas Nixon Carver and Albert Aftalion, among others, before John Maynard Keynes used it in his economic theories; however, it came into public knowledge as Keynesian theory began to dominate the field of economics in the 20th century.

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 policies. 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.

Example of the Accelerator Theory

Consider an industry where demand continues to rise at a strong and rapid pace. Firms 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, wind farm projects may be postponed, as renewable energy is economically less viable.

The Bottom Line

The accelerator theory states how capital investment increases in response to growth in demand or income; companies generally invest more as demand grows and an increase in income usually increases demand.

The theory helps guide policy, such as assisting governments to decide whether to stimulate demand or spur business expansion.