To produce a given amount of output, it requires a certain amount of capital. Jorgenson divided the variables into three main categories: capacity utilization, internal finance, and external finance. His investment equation has been derived from the profit maximisation theory of the firm. A further criticism of the basic accelerator model is that it ignores the spare capacity that a business might have at their disposal and also their ability to outsource production to other businesses to meet a short term rise in demand. Therefore, under the assumption of constant capital-output ratio, changes in output are made possible by changes in the stock of capital.
This will help policy makers to reduce the fluctuation in the aggregate demand. Thus monetary policy would be more effective in controlling a boom than in stimulating investment in recession. Its Criticisms: The financial theory of investment has been criticised on the following grounds: 1. Capacity utilization variables include output and the relationship of output to capacity. It will be further observed from Table 11. The accelerator theory was conceived before , but it came into public knowledge as the Keynesian theory began to dominate the field of economics in the 20th century. The constant of proportionality may be interpreted as the time rate of utilisation of capital stock that is the number of units of capital service per unit of capital stock.
It thus follows that investment is a function of change in income. It is also assumed that the demand for machines will remain stable in future, although the increase in demand has suddenly cropped up. When the economy is doing well, firms will invest to provide the extra capacity they need for increased production. Economists like Samuelson, Hicks and Dusenberry have shown how accelerator combined with multiplier provides an adequate and satisfactory theory of trade cycles that occur in the capitalist economies. This approach of breaking down a problem has been appreciated by majority of our students for learning Stock of capital, Capital - output ratio concepts. The Flexible Accelerator Theory or Lags in Investment: The flexible accelerator theory removes one of the major weaknesses of the simple acceleration principle that the capital stock is optimally adjusted without any time lag. This equation represents the naive accelerator.
Borrowed Funds: When the firm needs funds more than the retained earnings, it borrows from the banks or through the bond market. The size of the accelerator does not remain constant over time. Based on the theory, net investment is positive when output increases. The Neoclassical Theory of Investment: The theoretical basis for the neoclassical theory of investment is the neoclassical theory of the optimal accumulation of capital. Economists like Samuelson, Hicks and Dusenberry have shown how accelerator combined with multiplier provides an adequate and satisfactory theory of trade cycles that occur in the capitalist economies.
Junankar has discussed the lags in the adjustment between output and capital stock. As a result, the gross investment in period t- 1 will be equal to Rs. He said that cannot be. On the other hand, firms generally spend most of their retained earnings on technological improvements to reduce costs and on advertisement to increase their market share. The supply can be increased by reducing stocks of finished machines, by working extra shifts, and so on.
But, it is important to understand they are different concepts. Finally, if and when an expansion of productive capacity appears warranted, the expansion may not be exactly that needed to meet the current increase in demand, but one sufficient to meet the increase in demand over a number of years in the future. He explains them at the firm level and extends them to the aggregate level. On the other hand, the negative effect of an increase in capital stock, with income constant, will be much smaller than in the simple multiplier-accelerator model. It is thus assumed in the accelerator theory that th e machine-making industry is capable of increasing its output for the time being at least. Further, in the principle of acceleration principle it has also been assumed that in the capital goods industries, there exists surplus productive capacity. For example, it has been pointed out by Kaldor that we cannot assume a constant value of the accelerator throughout the trade cycle, that is, it is not true that an increase in output or income by an amount must always give rise to a multiple increase in investment.
Since as compared to the previous period, there is no change in output in period t-1, the net investment in period t-1 will be equal to zero. Hence, it is v, i. Fourth, the accelerator theory of investment, or acceleration principle, assumes a fixed ratio between capital and output. The parameter a represents the effect of changes in income on investment, while the parameter 3 represents the influence of capital stock on investment working through both the marginal efficiency of investment and profits. Theories of general equilibrium explain stationary states or steady, balanced growth. To meet this demand, investment in renewable energy sources and wind turbines increases. Similarly there are other resources e.
Some companies also meet an increase in demand by selling down their existing inventory. This influence results from the influence of capital stock on profits through the influence of profits on dividends on consumption. The opportunity cost of funds is the interest forgone which the firm could earn by investing its funds elsewhere. There may be the administrative lag of ordering the capital. Third, the model specification and specify the variables used in the model. If income or output increases over time, that is, when Yt is greater than Y t-1 then investment will be positive.