Business, Legal & Accounting Glossary
The accelerator principle defines the growth in output that would induce a continuation in net investment. In other terms, net investment is a function of the alteration in output. The accelerator principle has played an important role in defining the fluctuations in investment, which is an integral part of business cycle theories that are still used today.
The accelerator principle often assumes that the ratio of capital to output is retained at a constant level. For example, if a commercial entity producing leather bags invests $1,000 worth of equipment to produce $1,000 worth of products annually, and each year one-tenth of its equipment wears out, the total investment for a replacement would be $100 assuming that there is no growth or decline. In such a case, if the sale of leather bags increases by 5% to $1,050 annually, the amount of equipment will also rise by 5% to $1050. However, the total investment will increase by 50% to $150 to achieve the desired level. Consequently, it can be said that the companies desire to achieve constant capital-to-output ratio, a marginal percentage change in the sale of products can result in a higher percentage change in investment.
The accelerator principle can be used for inventories, although the term generally relates to business investments in companies and equipment. The use of the accelerator principle in investment facilitates one during business fluctuations in estimating swings in inventories.
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This glossary post was last updated: 29th March, 2020 | 1 Views.