The investment accelerator refers to the concept in macroeconomics describing the relationship between changes in economic output and capital investment. When demand in the economy increases, businesses respond by increasing investment in production capacity and capital equipment to meet this demand. This creates a multiplier effect where initial demand increase leads to greater business revenues and profits, which fund further investments and economic expansion. The multiplier effect illustrates how relatively small changes in demand can be amplified into larger total economic impacts through induced capital investment.
Economic demand triggers business investment
When an economy experiences rising demand for goods and services, companies will invest in expanding production capacity to capture more sales revenue from meeting this demand. If consumer spending rises 10%, companies may boost manufacturing equipment spending by 15% to be able to produce more goods to sell.
Investments increase economic output capabilities
As businesses invest in more factories, equipment, technology etc., this expands the economy’s future production capabilities. After a two year period of demand growth, the total output capacity of the economy would be notably larger due to the compounding impact of investment acceleration.
Multiplier effect amplifies economic growth
Higher production capacity allows companies to meet rising demand over time without shortages or supply bottlenecks developing. This encourages further demand growth in a virtuous cycle, as consumer confidence and incomes also rise on the back of economic expansion. The multiplier dynamic illustrates how small demand changes can cumulatively stimulate much larger total GDP growth when accounting for induced capital investment effects.
In summary, the investment accelerator multiplier principle demonstrates how rising economic demand spurs business investment in greater production capacity, enabling more output that can fulfill higher demand in the future. By quantifying these capital investment feedback effects, economists developed macroeconomic models better capturing the evolution of economic cycles over time.