Definition of accelerator effect

Accelerator effect

The accelerator effect suggests that a small change in national output (GDP) can trigger a larger change in aggregate investment. Underlying the accelerator effect is that real investment depends on business expectations, and on the divisibility of capital.

For example, a small increase in GDP, and hence aggregate demand, can provide positive expectations regarding future growth, and the need for business to restock their capital equipment, or to expand their scale of operations. However, because capital equipment is generally indivisible, firms must purchase capital on a larger scale than the actual change in aggregate demand warrants.

A simple example

If we take the simple example of a high street cafe which currently uses 2 coffee machines. These machines serve a maximum of 100 coffees a day each, providing a combined output of 200 coffees a day – sold to 200 customers. Currently, capital equipment is 2 coffee makers, which are used to their maximum capacity throughout the day.

If a new office now opens in the high street with 50 employees – each purchasing one coffee a day – then daily demand will have increased by 25% (i.e. from 200 to 250).

The cafe owner now faces a decision – how best to meet this new demand? Of course, the cafe could employ more staff, but this would not resolve the problem as the cafe is working at full capacity with its 2 machines in constant use. If the owner assumes demand will at least remain constant, and at best continue to grow, the most efficient option might be to purchase a new coffee making machine. If so, capacity would increase to 300 coffees per day, while demand is currently running at 250 coffees per day. An optimistic owner might feel justified especially if they assume demand will continue to grow, and, of course, the new machines will have a life of several years.

Hence, following the increase in demand of 25%, capital stock increases by 50%, and the ‘accelerator effect’ from this decision is ‘2’*.

Of course, at a macro-economic level, an accelerator effect is strongest when the current capital stock is running at full capacity, and where unemployment is approaching zero, or the non-accelerating inflation rate of unemployment (NAIRU).

* It is commonest to express the accelerator in terms of absolute numbers rather than percentage changes.

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Factors influencing the size of the accelerator

The size of any accelerator effect is amplified or moderated by several factors, including:

The extent of full capacity.
Business optimism.
The level of employment.
The life of the machinery/technology.
The initial capital cost of the machinery.
Government incentives to invest, such as tax allowance or investment subsidies.