Acceleration Principle and Business Cycle

This article provides short notes on acceleration principle and business cycle.

The introduction of the principle of acceleration enables us to understand the process of income generation more clearly.

No doubt, a certain level of the income (employment) could be attained by multiplier alone, but along with accelerator the process of income propagation is speeded up and more violent fluctuations occur in the upward and downward directions.

It enables us to throw light on one of the most important features of business cycle: the investment goods industries fluctuate more violently than the consumer goods industries.

It has shown that small changes in the consumption goods industries lead to considerable changes in investment industries. Prof. Hicks’ theory of the business cycle is based primarily on the principle of acceleration.

Prof. R.F. Harrod has based his theory of ‘Steady Growth’ on the acceleration principle. It can be seen from the working of the acceleration principle that investment and output follow a cyclical pattern. Numerous statistical studies show that investment spending is characterized by more extreme fluctuations than any other sector of the economy. W. Mitchell, for example, estimated that consumption spending rose by 15 per cent during periods of business expansion, while investment spending rose by 55 per cent and that consumption spending dropped by only 10 per cent during recessions, while investment spending dropped by 49 per cent.

The acceleration principle is very useful in explaining’ these business fluctuations because it shows how a relatively modest increase in consumption spending and output can lead to huge increases in investment spending and vice-versa. Thus, it describes an important element of instability in the economy because it shows how a period of prosperity can turn into a recession simply because demand levels off at a high instead of continuing to rise at a constant rate.

Investment demand thus is extremely sensitive to fluctuations in aggregate demand. This is because in most major industries it takes a huge investment in new capital to produce a modest net increase in output. In short, investment demand is extremely volatile. The volatility also works to cut investment demand sharply as soon as aggregate demand begins to level off. Only a constant absolute growth in aggregate demand can sustain a given level of investment beyond the replacement level, and only a steadily increasing rate of growth in aggregate demand can sustain an increasing level of investment demand.

Therefore, as soon as a boom begins to level off, investment demand begins to drop (in absolute terms), even if aggregate demand continues to grow rapidly than before. The effect of the accelerator is to sharpen the extremes (turning points) of the business cycle. A small increase in aggregate demand is accelerated into a business boom and when the pace slows down only slightly, the accelerator turns what might have been a mere leveling off into an economic depression.

At the bottom of the resultant depression, investment demand is so low for a time that little existing capital is even replaced. Then, as capital depreciation accumulates, some firms increase their investment demand from zero to the replacement level and the accelerator produces another upswing.

Despite its great theoretical importance, its qualifications and assumptions indicate that the attempts to apply very simplified models to illustrate the working of the acceleration principle would give entirely misleading results.

The presumption of a fixed ratio of consumer to capital goods, of constant replacement demand, of no excess capacity, of permanent increase in demand are lacking in realism. In other words, acceleration theory is valid only so long as all machines are in use (no excess capacity), overtime is excluded, the relation between production factors cannot be altered (unchanged technology), sufficient raw materials and labour are present and the entrepreneurs command the necessary financial means. Since this is not the case accelerator is of little significance.

The attempts to measure the accelerator have yielded little result. Entrepreneurs’ behaviour is to be explained through numerous other factors, especially future expectations play a particularly important part. More realistic assumptions would virtually lead to results different from those obtained under simplifying assumptions. It is significant to remember that Keynes completely ignored the principle of acceleration in the general theory. Instead of emphasizing the technical nature of the accelerator, he stressed the psychological concepts like multiplier, marginal efficiency of capital, liquidity, etc.

He believed that the ever changing nature of business expectations was more important in determining the volume of investment, and hence of employment, than the accelerator. Moreover, Keynes lived and wrote during depression when the manipulation of demand and the psychological factors was more important than an emphasis on technical factors on which the principle of acceleration depended. Much more than that, Keynes was conscious of the fact that the principle was a crude and highly unsuitable tool for analysis, as was clear from the pre-war writings on the subject.

The theory of accelerator is based upon ‘balanced’ growth; income and the stock of capital goods increase in the same proportion. This is not the case. Economic growth, furthermore, is not only dependent on capital. The accelerator is not competent to explain changes in aggregate investment. Only under special circumstances and in the short run is there a proportional relationship between output and the stock of capital goods.

The acceleration principle is less general than the multiplier whereas the latter operates in both directions, the accelerator is effective only in the upward direction (in the downward direction only to the extent that replacement in investment is not provided for).

Thus, it is clear at least three basic conditions must operate for a ‘pure’ accelerator model:

(i) Existing capacity if fully utilized,

(ii) Finances are adequate to permit satisfaction of accelerator-generated demand,

(iii) The change in output is thought to be non-temporary.

Such requirements obviously limit the generality of the principle.