Question

Explain the volatility of investments using the discussion on the accelerator effect. (Include MPC, Cobb Douglas and Real Rate in the answer, long-term and short-term)

Answer 1

Ans: The acclerator effect reflects that investment levels are connected to the rate of change of GDP. Therefore, an relative increase in the rate of economic growth will cause a greater increase in the level of investment . Since, a fall in the rate of economic growth will cause a fall in investment levels

It works like , if the firm observes any rise in demand and presumes this demand to be maintained , then it will rise to fuller capacity. And so, to meet this future demand, they will respond by investing only.

It is more productive to make a significant investment in order to see the economy scales in investment , rather than small annual increases (varies from 20% to 2%) respectively.

In addition , the economic growth stays the same , investments levels also remains the same . If GDP falls investment spending can fall too.

Cobb douglas theory:

When there is only a single factor other than capital-namely, labor-this amounts to assuming that the elasticity of substitution between capital and labor is unity, or that the production function is Cobb-Douglas