The accelerator principal is a theory aiming at explaining the level of investment in an economy. The theory claims that the level of investment depends on changes in national income and, more generally, output, demand or sales. The accelerator principal rests on the assumption that firms wish to maintain a fixed capital to output ratio; and it provides an additional reason for the observed instability of investment spend and, together with the multiplier effect, it is a theory explaining the existence of the business cycle.
These two principals (accelerator and multiplier) can potentially be linked together, because if the multiplier is used correctly, there is more income. This is definition and equation of the multiplier effect. The accelerator principal states that changes in income affect the investment. With more income, there is a change in the national income, which potentially brings about more investment. Both of these effects shift out the aggregate demand.
Level of investment depends on changes in national income (output, demand, sales). When an economy experiences a boom in prosperity firms in general experience rising profits. The firms will see opportunity to obtain more money by investing more (in more factories, machinery, etc.). The firm will experience higher profits thus stimulating consumer expenditure and an increase in income levels. This will cause a expansion as seen on the graph of the business cycle.
The accelerator effect also goes the other way: falling GNP (a recession) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages fixed investment, worsening a recession by the multiplier effect as seen on the business cycle graph.
Assume that firms wish to maintain a fixed capital to output level. For example a shoemaker needs one new machine for every 10,000 extra pairs of shoes. If sales rise by 20,000 the producer will change his stock to two extra machines.
The accelerator principal is a theory aiming at explaining the level of investment in an economy. The theory claims that the level of investment depends on changes in national income and, more generally, output, demand or sales. The accelerator principal rests on the assumption that firms wish to maintain a fixed capital to output ratio; and it provides an additional reason for the observed instability of investment spend and, together with the multiplier effect, it is a theory explaining the existence of the business cycle.
These two principals (accelerator and multiplier) can potentially be linked together, because if the multiplier is used correctly, there is more income. This is definition and equation of the multiplier effect. The accelerator principal states that changes in income affect the investment. With more income, there is a change in the national income, which potentially brings about more investment. Both of these effects shift out the aggregate demand.
Level of investment depends on changes in national income (output, demand, sales). When an economy experiences a boom in prosperity firms in general experience rising profits. The firms will see opportunity to obtain more money by investing more (in more factories, machinery, etc.). The firm will experience higher profits thus stimulating consumer expenditure and an increase in income levels. This will cause a expansion as seen on the graph of the business cycle.
The accelerator effect also goes the other way: falling GNP (a recession) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages fixed investment, worsening a recession by the multiplier effect as seen on the business cycle graph.
Assume that firms wish to maintain a fixed capital to output level. For example a shoemaker needs one new machine for every 10,000 extra pairs of shoes. If sales rise by 20,000 the producer will change his stock to two extra machines.