The accelerator model is very similar to the multiplier. The accelerator theory of investments assumes that firms’ output levels from the basis for expectations of future needs for capital. Or investments is assumed to be primarily linked to change in demand for output rather than to a change in interest rates. Firms experiencing an increase in demand will need to increase total capital. If output is growing at a constant rate, firms will also increase their capital spending at a constant rate. Whole an increase in growth will cause firms to increase desired investment levels.

To have a better understanding of this thory lets look at an exapmle...

Assume that a firm producing bottles for the soft drink industry bases expenditure on previous output levels. Furthermore, that one machine is needed for each million bottles produced and that for two years demand has been 20 million bottles per year. Thus, the form machines- and since the machines last for 10 years there has been no net investment for two years. Gross investment therefore increases from two to four, an increase of 100%, and net investment increase from zero to two. This the accelerator effect of an increase in aggregate demand, which incidentally also helps to explain why fluctuations in business cycles can be erratic and sudden, the compound effect on aggregate demand due to investment will accentuate the fluctuations.

Again the effect of the accelerator is that it enhances relatively mild changes in demand and increase business cycle amplitude. Yet there are number of weakness with the accelerator theory. Nowhere is it written that forms cannot adjust output by increasing the use of labor rather than capital-either by overtime or new hiring. On the upside, many businesses operate on excess capacity levels in order to be able to manage demand surges over shorter over period time periods. There are also time lag issues involved which cause the link between aggregate demand and addition to capital stock to be rather hard to finger.

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