accelerator effect
Here is something surprising about how businesses invest in new machines and factories. Their appetite for new capital depends not on how high sales are, but on how fast sales are changing. A bakery that sells a steady 1,000 loaves a day needs no new ovens — just enough to keep the existing ovens busy. But if sales start rising, it must buy extra ovens to keep up. The accelerator effect captures this: investment is driven by the change in demand, not its level.
The logic amplifies swings. Imagine a firm needs one machine for every 100 units of yearly sales, and machines last ten years. If sales hold steady at 1,000 units, it owns 10 machines and buys just 1 new machine a year to replace a worn-out one. Now suppose sales rise 10 percent, to 1,100. The firm now needs 11 machines, so this year it must buy the 1 replacement plus 1 extra — its investment doubles, from 1 machine to 2, off a mere 10 percent rise in sales. And if sales merely stop growing, that extra machine isn't needed and investment can collapse. So a modest change in consumer demand produces a magnified, even violent, change in investment spending.
The accelerator is a major reason investment is the most volatile part of aggregate demand and why business cycles can be so sharp. Paired with the multiplier, it can create self-reinforcing booms and busts: rising demand spurs investment, which (via the multiplier) raises incomes and demand further, which spurs still more investment — until growth slows, the accelerator throws investment into reverse, and the whole process runs backward. The honest caveat is that the simple accelerator assumes firms always have a fixed capital-to-sales ratio and no spare capacity; in reality firms hold buffers, expectations matter, and the relationship is looser and harder to predict than the clean formula suggests.
An airline expanding 5 percent a year keeps a steady stream of aircraft orders. The moment growth flattens to 0 percent, it doesn't need new planes at all, so its orders can drop to almost nothing — devastating for plane-makers, even though passenger numbers merely stopped rising rather than falling.
Investment tracks the change in demand, so even a slowdown in growth can crater capital spending.
The textbook accelerator assumes a fixed capital-to-output ratio and no spare capacity, so it overstates how mechanically investment reacts. In practice firms hold buffer capacity and act on expectations, loosening the link.