7 Restrictive Assumptions of the Investment Accelerator | Macro Economics

The following points highlight the seven restrictive assumptions of the investment accelerator. The assumptions are: 1. No Excess Capacity in Consumer Goods Industries 2. Surplus Capacity in Investment Goods Industries 3. Nature of Demand 4. Capital-Output Ratios 5. Availability of Resources 6. Elastic Credit Supply 7. Fluidity.

Restrictive Assumption # 1. No Excess Capacity in Consumer Goods Industries:

If there is already excess capacity in the consumer goods sector, a rise in demand for consumer goods will not lead to any induced investment or acceleration effects, because the increased demand may be met from the existing capital and machinery without producing additional capital goods.

This will be a case of zero gross investment and is the typical case during the initial period of recovery phase of the trade cycle.

When there is idle equipment or excess capacity, it is only after this excess capacity has been used that the principle of acceleration will start operating. This is what happened in India in Paper, Textile, Sugar and other industries during the Second World War.

Restrictive Assumption # 2. Surplus Capacity in Investment Goods Industries:

On the other hand the operation of the principle depends upon the presumption that there is surplus capacity in the investment goods industries. If it were not so, i.e., no excess capacity existed in machine-making industries, an increase in the derived demand for machines would not induce an increased supply of machines.

The operation of the investment accelerator is conditioned by the ability of the machine- making industry to produce increased number of machines with their existing equipment, if need be; in other words, there must be surplus capacity in investment goods industries.

Failing this the delivery dates shall have to be postponed and the working of the investment accelerator to that extent will be impaired. Hence, the principle of acceleration depends upon a very tough condition that there shall be excess capacity in one type of industry (investment industry) but no excess capacity the other industries (producing consumer goods).

Restrictive Assumption # 3. Nature of Demand:

The increase in the demand for consumption goods must be more or less permanent in nature to have acceleration effects. A purely temporary increase in the demand for consumer goods will not lead to any addition in the capital goods.

Durable capital goods are expensive and no producer of consumer goods will order capital goods if he believes that the increase in demand is short ­lived. This also shows that the acceleration principle is not only based on technological factors but also on profit expectations (a point which has often been overlooked by the exponents of this principle).

Restrictive Assumption # 4. Capital-Output Ratios:

The principle of acceleration is based on the assumption that there is a constant ratio of the output of consumer goods and capital equipment needed for their production i.e., there is constant capital output ratio. In reality this ratio is not necessarily constant.

When there is a heavy pressure of demand for consumer goods apart from the inventions and improvements in the technique of production (which allow for an increase in output per unit of capital equipment), existing capital equipment may be worked more intensively.

Moreover, with the change in the expectations of businessmen regarding future trends in wages, interest and demand, the proportions in which factors are combined may vary.

Hence, capital- output ratio also varies in different phases of the business cycle and accordingly the realized value of the capital coefficient may be much less than or more than the expected value depending upon the changes in techniques. Thus, the value of the investment accelerator depends directly on changes in the capital-output ratio.

Restrictive Assumption # 5. Availability of Resources:

The working of the investment accelerator principle is further restricted by the availability of resources and the ability of the machine-making industry to produce more-machines. In order that the increased demand for capital goods be followed by an increase in production there must be enough unemployed resources available for employment in the capital goods industries i.e., these industries should be able to expand.

This is possible only when there is wide-spread unemployment in the economy. But once the level of full employment has been attained, the industrial sector finds it difficult to expand the production of capital goods. The upper limit to the working of accelerator is the full-employment (capacity) level.

Restrictive Assumption # 6. Elastic Credit Supply:

The elastic supply of credit is another factor which helps in the smooth working of the investment acceleration principle. Whenever there is induced investment as a result of induced consumption, enough credit should be forthcoming for investment in investment-goods industries.

Scarcity of credit will raise the rate of interest and will make investment financed by borrowed funds costlier. It is, therefore, essential that the rate of interest does not rise and that there is enough credit to allow for the acceleration effects to follow.

Restrictive Assumption # 7. Fluidity:

Operation of the acceleration is also based on the assumption that the investment-goods industry is in fluid condition. It assumes that “…. finished goods are turned out as fast as wanted and materials and means of production are instantly supplied as fast as the process of finishing requires them.” There is no loss of production in time.