What Is... 'The Accelerator Principle?'

Image copyright: Melanie Tsoi, from stock.xchng.

To produce goods, a firm needs equipment. Imagine that a machine is capable of producing 1,000 CDs per week. Demand for CDs is currently 800. A rise in demand for CDs might therefore be capable of being met without any further investment in new machinery. However, if the rate of growth of demand continues to rise, it may be necessary to invest in a new machine.

Imagine that in year 1, demand for CDs rises by 10% to 880. The business can meet this demand through existing equipment. In year 2, demand increases by 20% and is now 1,056. The existing capacity of the machine means that this demand cannot be met but the shortage is only 56 units so the firm decides that it might increase price rather than invest in a new machine. In year 3, demand rises by a further 25% . Demand is now 1,320 but the machine is only capable of producing a maximum of 1,000 CDs. The firm decides to invest in a new machine. The manufacturers of the new machine will therefore see a rise in their order books as a result of the increase in demand. As a result of the increase in demand of 25%, the rise in investment is 100%.

If, however, in the next year the demand falls then the firm manufacturing CDs may cut its investment and therefore the level of investment falls as well.