Question

Under what circumstances would you expect a rise in national income to cause a large accelerator effect.

Answer 1

The accelerator effect can be explained as the fact that an increase in consumer demand bringing bout a more than porportional increase in investment in capital goods. This can be the highest in the following scenarios -

1. When the companies are almost working in full potential. If the companies are wokring in full potential, then additional output can be possible only when the company expands and invests more in increasing capital stock. Hence, if the national income rises the people's incomes and hence their demand, the conpmaies working close to full capacity will have to invest more to expand their operations and get more productive capital so that they can accomodate the increasing demand. This means there should be investment more than what is required to overcome the wear and tear of the existing capital instruments.

2. When the companies have little space left to produce more at their given level of capital. Some firms will have additional space left to produce more when the economy expands. This should not be possible, as in there should not be any idle capacity with the companies.

3. When additional investmnets are feasible. For this, the interest rates in the economy should be low enough to attract more investments. If the cost of borrowings is low, then the firms have incentive to borrow from the banks and to invest, and hence there will be a larger accelerator effect.