The Accelerator Theory – The Theory states that relatively small variations in national income (NY) will bring about much greater changes in the level of demand for capital goods, so changes in national income determine the level of new investment (I). This is largely based on the fact that it takes several £ worth of Capital to produce one £ of GDP, so capital stock must be much greater than GDP.
Example: A bus company operating at full capacity experiences a 10% increase in demand, the company currently has 10 buses and will need 1 additional bus to keep up with demand. Buses cost £50,000 and they last 10 years. Each year they have to invest in one bus to replace an old one but with the extra demand now they need to invest in two. This has caused investment to double (£50,000 to £100,000), so a 10% increase in demand has caused a 100% increase in investment.
Flaws to the theory:
-If firms aren’t confident the demand is long term then firms may fail to invest and try more short term methods for filling demand e.g. hiring buses.
-Firms may just increase their prices to contract demand and make higher profits rather than meeting the extra demand.
-If there’s not enough skilled workers to fill the positions e.g. Qualified bus drivers, then there is no point in investing in capital.