The term accelerator in economics is used to convey the accelerator principle. This theory suggests that there is a direct relationship between the changes in output or demand in the economy and the level of investment in new capital goods. According to the accelerator principle, an increase in demand for products leads to a greater increase in investment as businesses invest more in capital goods for meeting the rising demand. On the other hand, a decrease in demand leads to a sharp reduction in investment.
Consider accelerator as a type of multiplier effect in economics. When people start buying more products, the companies need to increase their production. To do so, they often have to invest in new machinery or expand their factories. So, a small increase in sales can lead to a much larger increase in investment by businesses. The opposite also holds true. If sales decrease, the businesses will cut back on their investments in new equipment.
This concept is widely used in macroeconomics specially in the analysis of business cycles and also in policy making. The accelerator principle helps in explaining as to why economic downturns can lead to significant reductions in investment and why recoveries often witness substantial increase in investment.
Let us see when it can be used:
- In case of increase in consumer demand for automobiles, car manufacturers may invest heavily in new manufacturing plants and machinery to increase the production capacity.
- During recession, the consumer spending is falling, the businesses may cut back on investments in new equipment drastically which might lead to a deeper downturn in the economy.
Source: A to Z of Economics by Dr. NC Raghavi Chakravarthy