Acceleration Principle in Economics: Meaning, Working and Operation

Read this article to learn about the meaning, working and operation of acceleration principle in economics.

Meaning:

The multiplier and accelerator are not rivals but parallel concepts. While the multiplier shows the effect of investment on consumption (and employment), the accelerator shows the effect of a change in consumption on investment.

Hayek explains the central idea of the principle in these words: “Since the production of any given amount of final output usually requires an amount of capital several times larger than the output produced with it during any short period (say a year) any increase in final demand will give rise to an additional demand for capital goods several times larger than the new final demand.”

The principle of acceleration states that if demand for consumption goods rises, there will be an increase in the demand for factor of production, say machine, which goes to produce the goods.

But the demand for machines will increase at a faster rate than the demand for the product. The accelerator, therefore, makes the level of investment a function of the rate of change in consumption and not of the level of consumption.

In other words, the accelerator measures the changes in investment goods industries as a result of changes in consumption goods industries, The idea underlying the accelerator is not so much one or ever rising demand as of a functional relationship between the demand for consumption goods and the demand for the machines which make them. The acceleration coefficient is the ratio between the induced investments to a net change in consumption expenditures.

Symbolically α = ∆I/∆C, where a stands for acceleration coefficient; ∆I denotes the net changes in investment outlays; and ∆C denotes the net change in consumption outlays. Suppose an expenditure of Rs. 10 crore on consumption goods leads to an investment of Rs. 20 crore in investment industries, then the accelerator is 2.

It could be one or even less than that. In actual practice, however, increased expenditures on consumption goods always lead to increased expenditures on capital goods. Hence acceleration is usually more than zero. Where a good deal of capital equipment is needed per unit of output, acceleration coefficient is positive and more than unity.

Sometimes, it so happens that the production of increased consumer goods (as a result of a rise in their demand) does not lead to an increase in the capital equipment producing these goods. The existing machinery also wears out on account of the constant use, with the result that the increased demand for consumer goods cannot be met.

It actually happened in India and Turkey during the Second World War. In the absence of induced investment and acceleration effects, the increased demand of consumption goods leveled off and the accelerator, which measures the effects of induced investment (in investment goods industries) as a result of changes in consumption, did not seem to work during all these years. The factual basis of the acceleration principle is the knowledge that the fluctuations in output and employment in investment goods industries are greater than in consumption goods industries.

Acceleration has greater applicability to the industrial sector of the economy and as such it seeks to analyse the problem as to why fluctuations in employment in the capital goods industries are more violent than those in the consumption goods industries. There would be no acceleration effects in an economy that used no capital goods. But that is very rare. The more capitalized the methods of production are, the greater must be the value of the accelerator.

As the nature of acceleration is, it has been widely used to explain fluctuations in economic activity, especially in the investment goods industries. Nevertheless, the accelerator cannot and does not claim to be able to explain all kinds of fluctuations in investment goods industries. For example, the prices of raw materials sometimes fluctuate more violently than the prices of investment goods because the supply of raw materials, especially agricultural commodities, is much more inelastic in response to the changes in demand than is the supply of manufactured goods.

Multiplier and Accelerator Distinguished:

For a clear grasp of the concept of accelerator, it is useful to distinguish between multiplier and accelerator as the two concepts are likely to be confused. Multiplier shows the effect of the change in investment on income and employment and the accelerator shows the effect of a change in consumption on investment. In other words, in the case of multiplier, the consumption is dependent upon investment, whereas in the case of accelerator investment is dependent upon consumption. Further, multiplier depends upon the propensity to consume and the accelerator depends upon durability of the machines.

In other words, the former is dependent upon psychological factors, while the latter is dependent upon technological factors. However, even accelerator is psychological in its origin and content but becomes highly technical on operational plane. The accelerator shows the action (effects) of growth of consumption on investment and the multiplier shows the reaction of consumption to increased investment.

Its Working and Operation:

In case I in the above table, we find that we need 100 machines to produce 1000 consumer goods (capital output ratio being 1:10). Further we presume that the life of the machine (durability) is 10 years. Thus, after 10 years, the machine has to be replaced and 10 machines have to be replaced in each period in order to maintain a flow of 1000 consumer goods. This is called ‘Replacement Demand’. Now suppose there is 10 per cent rise in the demand for consumer goods in period I (as shown in case I), the change in consumption will be 1100 goods and we will need 110 machines to produce these goods (at the constant capital-output ratio of 1: 10).

Thus, we need 20 machines in all, 10 machines being addition to the total stock of capital and 10 machines for replacement. Thus, a 10 per cent rise in the demand for capital goods leads to a 100 per cent rise in the demand for investment goods (machines). This is what the principle of acceleration tends to show, i.e., it shows that a small increase in consumption is likely to result in manifold increase in investment (called induced investment).

Now in case II, when the life of the machine is 20 years, a 10 per cent rise in the demand for consumer goods in the first period leads to 200 per cent increase in gross investment. Further, in case III, when the life of the machine is 5 years, a 10 per cent rise in the demand for consumer goods Results merely in an increase of 50 per cent in the gross investment. It is, therefore, clear the greater the durability (life) of the machine, the greater the value of the accelerator and higher the acceleration effects; and smaller the durability, lower the value of the accelerator and lower are the acceleration effects.

In case IV, where we presume the life of the machine to be 10 years and capital-output ratio constant at 1: 10 (i.e., we need 100 machines to produce 1000 goods), we find that a 10 per cent rise in period I, in consumption goods, leads to 100 per cent increase in gross investment, whereas in period II, when the demand for consumer goods does not rise and remains constant at 1000, there is a decline of 50 per cent in gross investment.

Thus, we find that even, when there is no decrease in the demand for consumer goods, there is likely to be a decline in gross investment. It is to be noted that it is the falling off in the rate of increase in consumption and not a decline in the absolute level of consumption which causes the contraction in the demand for machines.

Further, in case V, presuming the life of the machine to be 10 years, we find that we need 110 machines to produce 1000 consumer goods. But when there is a fall in the demand for consumer goods to the extent of 10 per cent in period I, we need 90 machines to produce 900 goods, there is 100 per cent fall in the gross investment (with only 10 per cent fall in the demand for consumer goods).

If, however, the demand for consumer goods falls by 20 per cent, we will need 20 per cent less machines and correspondingly we can expect the rate of investment to fall by 200 per cent. But at the most what the producers can do is to produce no machines at all i.e., not to replace existing machines.

They may allow some of the existing plants and equipment to lie idle. Thus, when the economy is moving downwards, the fall in investment becomes confined to the demand for replacement and can at the most fall to zero. In other words, the value of the accelerator during downward swing is limited by the inability of the demand for investment goods to fall below the value of replacement (depreciation) demand, i.e., a decline in investment resulting from a decline in the demand for consumption goods – cannot exceed depreciation.

A decline in consumption which is in excess of depreciation figure simply gives rise to excess idle capacity. The so-called ‘accelerator’ (demand for capital goods) is a highly dangerous tool, for it depends upon the change in the rate of consumption, which, in turn, depends upon highly capricious investment in the short period, at any rate. Therefore, as long as the basic conditions (technological and structural) favouring investment prevail, the acceleration principle serves as an inducement to invest.

Thus, the acceleration principle holds that investment demand is dependent on increases in output, because such increases put pressures on firms to expand their stocks of capital goods. According to the accelerator theory, investment occurs to enlarge the stock of capital because more capital is needed to produce more output. It is, no doubt, true that within limits, firms may be able to produce more output with existing capital through more intensive use, but there is, at any time, a particular ratio of capital to output (capital-output ratio) that firms consider optimum.

This ratio varies considerably from firm to firm and from industry to industry—much more capital is used per dollar of output in the car industry than in the tailoring industry. At any time, there is a particular ratio that is the desired ratio for the economy as a whole over time, this ratio will change as the mix of output changes—more cars and less clothes or vice-versa. In order to reduce the complication it is assumed that this ratio (capital-output) remains unchanged or constant over time.

With K representing the capital stock, Y the level of output and w the capital-output ratio, we have:

K = wY

If the C/O is 2, then K of Rs. 400 is desired for Y of Rs. 200 and K of Rs. 450 for Y of Rs. 225. Since C/O is constant over time. K (the desired stock of capital) will change over successive time periods only with changes in output (Y). Denoting a particular time period by t, preceding time periods are t – 1 ant t – 2 and future of subsequent time periods are t + 1 and t + 2. Assume that in the preceding period (t – 1) the desired capital stock was enough to produce the level of output of the period t – 1. That is:

K_{t – 1}= wY_t-1

If output rise from Y_t–1 to Y_t, the desired capital stock would also rise from K_t–1 to K_t that is:

K_t = wY_t

This increase in the desired stock of capital is K_t – K_{t- 1}. To get this increase in capital stock, additional net investment is needed—this net increase in net investment expenditure is equal to the change in capital stock, that is:

I_t = K_t K _t-1 …(i)

where I₁ is net investment in period t. By substituting wY_t for K_t and wY _t-1 for K_t–1, we get

I_t, = wY_t – wY _t-1 = w(Y_t – Y _t-1)…(i)

This equation simply means that investment during a particular time period (t) depends on the changes in output from t-1 to t multiplied by capital-output ratio (w). If Y_t >Y _t-1 the equation shows that there is positive net investment during the period t—if Y_t < Y_t–1, there is negative net investment, or disinvestment during period t. If, however, we want to show gross rather than net investment, all that is needed is to add replacement investment to both sides of the equation. This replacement investment is taken to be equal to depreciation and is shown by D_t, we have thus:

I_t + D_t = w(Y_t – Y _t-1) + D_t

But as has been shown in case V in the above table the negative net investment in plant and equipment is limited to the amount of depreciation of the capital stock, the sum of I_t and D_t cannot be less than zero. If Ig_t represents gross investment in period t. we have:

I_gt = w(Y_t – Y _t-1) + D_t …(iii)

Investment will respond to changes in the level of output shown by the equation only if certain assumptions are satisfied, the most important being the absence of excess capacity, if X, shows the excess capacity at the beginning of the period t, we may rewrite equation (iii) as:

I_gt = w (Y_t – Y_t-1) + D_t – X_t

Whatever the level of gross investment might otherwise be in period t, it will be reduced by the amount of X_t. If the value of w(Y_t – Y _t-1)+D_t, happened to be equal to or less than X_t—then I_gt, would be zero—the minimum possible for gross investment in plant and equipment as elaborated by case V in the table already given.

The sets of equations just developed in support of the illustrative cases I to V in the table already given are significant, at least for two reasons:

Firstly, they indicate the causal relationship between changes in output and investment spending.

Secondly, they point out to the fact that the investment spending resulting from a change in output is likely to be larger than the changes in output that caused it.

This will be true in every case where w is higher than one—that is, where the amount of capital needed to produce a given output is larger than the value of the output. This lies at the heart of the acceleration principle.