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Term: Accelerator Theory

19 Nov 2015

DEFINITION of ‘Accelerator Theory’
An economic theory that suggests that as demand or income increases in an economy, so does the investment made by firms. Furthermore, accelerator theory suggests that when demand levels result in an excess in demand, firms have two choices of how to meet demand.

  • Raise prices to cause demand to drop.
  • Increase investment to match demand.

The accelerator theory proposes that most companies choose to increase production thus increase their profits. The theory further explains how this growth attracts more investors, which accelerates growth.

BREAKING DOWN ‘Accelerator Theory’
The accelerator theory was developed early in the twentieth century by Thomas Nixon Carver and Albert Aftalion, among others. Although this theory was conceived before Keynesian economics, it emerged just as the Keynesian theory came to dominate the economic mindset of the twentieth century. Critics argue that accelerator theory should not be used because it eliminates the possibility of controlling demand through price controls. However, empirical research on the accelerator theory has supported its use.

The accelerator theory is interpreted to create economic policies. For example, would it be better to use tax cuts to create more disposable income for consumers who would then demand more products, or would it be faster to give those cuts to business, which will then be able to use more capital for growth? Every government and their economists create their own interpretation of accelerator theory and the questions it can be used to answer.

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