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ACCELERATOR THEORY OF INVESTMENT

The document discusses the accelerator theory of investment. It explains that the accelerator principle states that an increase in a firm's output will require a proportional increase in its capital stock. The accelerator coefficient (v) represents the ratio of induced investment to an initial change in consumption. The naive accelerator model holds that net investment (Int) is equal to v multiplied by the change in output (ΔYt). Refinements to the simple accelerator model include allowing for asymmetrical reactions to increases and decreases in output, and assuming variable rather than fixed technical coefficients of production.

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THE ACCELERATOR THEORY OF INVESTMENT Dr. M.MADHAVAN Assistant Professor PG & Research Department of Economics Arignar Anna Government Arts College Namakkal – 637 002 1
INTRODUCTION  T.N. Carver was the earliest economist who recognised the relationship between changes in consumption and net investment in 1903. But it was Aftalion who analysed this principle in detail in 1909.  The term “acceleration principle” itself was first introduced into economics by J.M. Clark in 1917.  It was further developed by Hicks, Samuelson, and Harrod in relation to the business cycles. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 2
THE PRINCIPLE OF ACCELERATION  The principle of acceleration is based on the fact that the demand for capital goods is derived from the demand for consumer goods which the former help to produce.  The acceleration principle explains the process by which an increase (or decrease) in the demand for consumption goods leads to an increase (or decrease) in investment on capital goods.  According to Kurilara, “The accelerator coefficient is the ratio between induced investment and an initial change in consumption expenditure”. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 3
Contd……  Symbolically,  v =ΔI/ ΔC or ΔI = v ΔC  If the increase in consumption expenditure of Rs 10 crores leads to an increase in investment of Rs 30 crores, the accelerator coefficient is 3. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 4 Where, • v is the accelerator coefficient, • ΔI is net change in investment and • ΔC is the net change in consumption expenditure.
THE ACCELERATOR THEORY OF INVESTMENT  we shall discuss some of the post-Keynesian theories of investment and refinements in the accelerator theory. First, we explain the simple accelerator principle in its crudest form which is known as the naive accelerator.  The accelerator principle states that an increase in the rate of output of a firm will require a proportionate increase in its capital stock.  The capital stock refers to the desired or optimum capital stock. K*. Assuming that capital-output ratio is some fixed constant, v, the optimum capital stock is a constant proportion of output so that in any period t. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 5
Contd……  K = vY,  where K * is the optimum capital stock in period t,  v (the accelerator) is a positive constant, and  Yt is output in period t.  Any change in output will lead to a change in the capital stock. Thus K*t - K*t-1 = v(Yt – Yt-1) and Int = v (Yt – Yt-1) [Int = K*t - K*t-1] = v ΔYt  Where ΔYt = (Yt – Yt-1), and Int , is net investment. This equation represents the naive accelerator. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 6
Contd……  In the above equation, the level of net investment is proportional to change in output. If the level of output remains constant (ΔY = 0), net investment would be zero. For net investment to be a positive constant, output must increase. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 7
Contd……  This is illustrated in Figure 1 where in the upper portion, the total output curve Y increases at an increasing rate upto t + 4 period, then at a decreasing rate upto period t + 6.  After this, it starts diminishing. The curve In in the lower part of the figure, shows that the rising output leads to increased net investment upto t +4 period because output is increasing at an increasing rate. But when output increases at a decreasing rate between t +4 and t + 6 periods, net investment declines. When output starts declining in period t + 7, net investment becomes negative. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 8
Contd……  The above explanation is based on the assumption that there is symmetrical reaction for increases and decreases of output.  In the simple acceleration principle, the proportionality of the optimum capital stock to output is based on the assumption of fixed technical coefficients of production. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 9
Contd……  This is illustrated in Figure 2 where Y and Y1, are the two isoquants. The firm produces Y output with K* optimal capital stock. If it wants to produce Y1 output, it must increase its optimal capital stock to K*. The ray OR shows constant returns to scale. It follows that if the firm wants to double its output, it must increase its optimal capital stock by two-fold.  Eckaus has shown that under the assumption of constant returns to scale, if the factor-price ration remain constant, the simple accelerator would be constant. Suppose the firm's production involves the use of only two factors, capital and labour whose factor-price ratios are constant. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 10
Conti……  In Figure 3, Y, Y1 and Y2 are the firms' isoquants and C, C1 and C2 are the isocost lines which are parallel to each other, thereby showing constant costs. If the firm decides to increase its output from Y to Y1 it will have to increase the units of labour from L to L1 and of capital from K* to K1* and so on. The line OR joining the points of tangency e, e1, and e2 is the firms’s expansion path which shows investment to be proportional to the change in output when capital is optimally adjusted between the isoquants and isocosts. Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 11
Thank you manimadhavan@gmail.com Dr.M.Madhavan, Asst. Professor, PG & Research Department of Economics 12