This may lead to further growth of the economy through the stimulation of consumer incomes and purchases, i.e., via the multiplier effect.
In simpler terms, it is the acceleration or deceleration of economic growth that shapes businesses' choices regarding investments.
[1] The accelerator effect operates in reverse as well: when the GDP declines (entering a recession), it negatively impacts business profits, sales, cash flow, capacity utilization, and expectations.
Consequently, these factors discourage businesses from making fixed investments, which further intensifies the recession due to the multiplier effect.
This is because high levels of aggregate demand hit against the limits set by the existing labour force, the existing stock of capital goods, the availability of natural resources, and the technical ability of an economy to convert inputs into products.
John Maynard Keynes first introduced the idea in his seminal work "The General Theory of Employment, Interest, and Money," published in 1936.
Keynes recognized that changes in investment are not solely driven by interest rates but are also influenced by the level of demand for goods and services.
Some have incorporated additional factors such as technological change, expectations, and financial constraints to enhance the accuracy of investment predictions.
This means that the simple accelerator model implies that fixed investment will fall if the growth of production slows.
Thus, the simple accelerator model implies an endogenous explanation of the business-cycle downturn, the transition to a recession.
Because the existing capital stock grows over time due to past net investment, a slowing of the growth of output (GDP) can cause the gap between the desired K and the existing K to narrow, close, or even become negative, causing current net investment to fall.
Obviously, ceteris paribus, an actual fall in output depresses the desired stock of capital goods and thus net investment.
In the neoclassical accelerator model of Jorgenson, the desired capital stock is derived from the aggregate production function assuming profit maximization and perfect competition.
In Jorgenson's original model (1963),[6] there is no acceleration effect, since the investment is instantaneous, so the capital stock can jump.