An injection of new purchasing power through investment induces only consumption expenditure and the induced consumption expenditure, in its turn, may induce the demand for consumer goods.
It is a common experience that capital goods industries are subject to violent fluctuations. The acceleration theory attempts to explain the nature of the instability of capital goods industries in general and the exaggerated effects of change in consumption expenditure upon investment in particular.
Just as the change in consumption expenditure is functionally related to the change in investment through the multiplier, so is the change in investment outlays related to the change in the rate of consumption expenditure through the acceleration coefficient.
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The latter function measures the leverage effect of an increment in the rate of consumption on the volume of investment.
The acceleration coefficient is the ratio between a net change in consumption outlays and the induced investment. It measures the functional relation between two marginal magnitudes, between a net change in consumption outlays and a net change in investment outlays.
For example, if we find that a net increase in the rate of consumption expenditure equal to Rs. 5 crores leads to a net increase in investment outlays equal to Rs. 10 crores, we shall conclude that the acceleration coefficient is 2.
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For technical and other reasons, there is always some such relation between the production of consumption goods and that of capital goods.
The acceleration coefficient may be zero, if the production of consumer goods involves no capital equipment or if the production of consumer goods demands no deepening of capital. The former is conceivable where round-about capitalistic production is rare as in an under-developed economy.
The latter case is possible when technological innovations are of capital-saving nature. If, on the other hand, a great deal of new capital is required per unit of output then the acceleration coefficient must be positive and perhaps greater than unity.
The acceleration coefficient would be far less than 1, and have little accelerated effect on investment if (i) there is excess equipment, (ii) the new demand for consumer goods am expected not to last and (iii) the demand for capital depends largely on ‘exogenous’ factors.
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Less than full employment of equipment enables additional output to be produced without producing additional capital goods.
This is a case of zero gross investment. Moreover, if the demand for consumer goods is expected not to last long, the producers will hesitate to make long-term capital outlays. Autonomous investment does not depend on consumption expenditure.
Some types of capital outlays may go on regardless the level of income. There are always some exogenous factors in operation to affect investment decisions independently of the level of income. Assuming that none of the above conditions exist, we can say that greater the value of acceleration coefficient, greater the induced investment.
The acceleration principle has some limitations. It is not legitimate to assume a fixed production function under the impact of a change in demand for consumer goods.
There is every possibility that the technique of production may vary in accordance with the changes which are found in the relative prices of the factors of production. Neglect to take account of the effects of changing demand on relative factor prices are one of the limitations of the acceleration principle.