Its importance is further explained as below: 1. This is because there are several leakages from the income stream as a result of which the process of income propagation is slowed down. Saving-Investment Equality: The multiplier process helps to understand how equality between saving and investment is brought about. At the end of one year, let us suppose, that one machine becomes useless as a result of wear and tear, so that at the end of one year, a gross investment of Rs. Multiplier-Accelerator Interaction Theory Multiplier-Accelerator Interaction Theory Definition: The Multiplier-Accelerator Interaction Theory came into existence when the theorist of the Keynesian tradition stresses on multiplier process in economic fluctuations while J. The fiscal multiplier effect is important here too. The acceleration principle is weak in that it neglects profits as a source of internal finance.
Assume that in the preceding period t — 1 the desired capital stock was enough to produce the level of output of the period t — 1. There would be no acceleration effects in an economy that used no capital goods. The changes in investment during the different phases of the trade cycle may therefore be several times that of the rise or fall in income. With a multiplier value of 4, an initial £500 million of extra spending results in a £2 billion increase in national income, as Fig. These workers in turn spend their earnings on other goods and , which fuels. At some point — and if they feel that the higher level of demand will be sustained — they may choose to increase spending on capital goods such as plant and machinery, factories and new technology in order to increase their capacity.
The acceleration principle explains the process by which an increase or decrease in the demand for consumption goods leads to an increase or decrease in investment on capital goods. While the multiplier shows the effect of investment on consumption and employment , the accelerator shows the effect of a change in consumption on investment. What determines the value of the multiplier? This eventually leads to a decline in the volume of induced investment. For example, if a government spends a certain amount of building a bridge, it must hire and pay workers to do so. The multiplier measures how much each dollar the government spends increases economic growth. Nevertheless, the accelerator cannot and does not claim to be able to explain all kinds of fluctuations in investment goods industries. Therefore, to fill this gap, the government comes forward and undertakes the investment in her own hands.
The dynamic path of income is shown in the adjoining Fig. Figure-3 shows the effect of leakage. Empirical studies show that the relationship between income and consumption is complicated and non-linear and not as simple as assumed by Keynes. It is to be noted that it is the falling off in the rate of increase in consumption and not a decline in the absolute level of consumption which causes the contraction in the demand for machines. Many governments in developed nations have been introducing fiscal austerity programmes — cutting spending and lifting taxes in a bid to lower their budget deficits.
It is an up-to-date, most modern and a highly streamlined theory which incorporates all the best attributes of earlier models and scrapped all those which were not proved out in the past. To figure that out, they will just divide the total amount of money needed by the multiplier. An increase in investment leads to increase in income. At this point, total income has grown by £300m + 0. Meaning : The multiplier and accelerator are not rivals but parallel concepts.
If by anticipating future demand, capital equipment has already been installed, it would not lead to induced investment and the acceleration effect will be zero. Income Generation Process: The theory of multiplier not only indicates the direct creation of income and employment, it also reveals that income is generated in the economy like a stone causing ripples in the lake. The accelerator, therefore, makes the level of investment a function of the rate of change in consumption and not of the level of consumption. The net import is a leakage. However, even accelerator is psychological in its origin and content but becomes highly technical on operational plane.
The acceleration principle is illustrated diagrammatically in Figure 1 where in the upper portion, total output curve Y increases at an increasing rate up to t+4 period, then at a decreasing rate up to period t+6. Initially, however, the increased demand will be met by over-working the existing plants and machinery. The Accelerator: The multiplier describes the relationship between investment and income, i. Significance of Multiplier — Accelerator Interaction : In order to measure the total effect of initial investment expenditure on income, it is necessary to combine the effects of multiplier and accelerator. One problem is that the actual value of the multiplier effect is likely to change at different points of the economic cycle. This is super-multiplier effect or the combined effect of multiplier and accelerator. In more general theory, where the capital decision determines the desired level of capital stock which includes and , and the investment decision determines the change of capital stock in a sequences of periods, the acceleration effect emerges as only the current period gap affects the current investment, so do the previous gaps.
This lies at the heart of the acceleration principle. Later on the economists like, Hicks, Samuelson and Harrod, further developed this principle to explain the business cycles. The accelerator, therefore, makes the level of investment a function of the rate of change in consumption and not of the level of consumption. The equation tells that gross investment during period t depends on the change in output Y from period t — 1 to period t multiplied by the accelerator v plus replacement investment R. Imports: Net imports form another leakage in the domestic income stream. It is, therefore, inadequate as theory of investment.
The downside to this is that the same thing happens when output slows as this leads to a fall in investment, which has negative multiplier effects. The induced consumption of Rs. Sometimes, it so happens that the production of increased consumer goods as a result of a rise in their demand does not lead to an increase in the capital equipment producing these goods. This model was developed by , who credited for the inspiration. As a result of leakage, income in each period increases only by the amount of induced consumption. Moreover, the accelerator is also responsible for causing fluctuations in national income while reaching the level as indicated by the multiplier.