Multiplier and Accelerator Theory Essay

Multiplier and accelerator theory The Keynesians, have offered a demand side explanation of the business cycle. According to them, the fluctuations in output and employment in the country are caused by fluctuations in aggregate demand. The ups and downs in aggregate demand are caused by changes in the volume of investment. The volume of investment is directly related to the marginal efficiency of capital. The investment increases in response to higher marginal efficiency of capital and decreases with the fall in the profit expectations of the entrepreneurs. The Keynesians further put forward the theory of multiplier which shows how the increase or decrease in investment causes multiplied changes in income and employment and thus heightens a boom or deepens a depression. The Keynesians failed as they did not explain the cyclical nature of the ups and downs in business cycle. J. R. Hicks and Professor Samuelson put forward a new theory of business cycle named as Multiplier and Accelerator Theory of business cycle.†¨Ã¢â‚¬ ¨Multiplier and Accelerator Theory†¨According to J. R. Hicks and Samuelson, the multiplier alone cannot explain the cyclical nature of the business cycle. It is the interaction between the multiplier and accelerator that explains the emergence of different phases of business cycle. The multiplier tells us that a change in the level of autonomous investment brings about a relatively greater change in the level of national income. The accelerator theory states that the current investment spending depends positively on the expected future growth of real GDP. When real GDP growth is expected to be high, firms anticipate that their investment in plants and equipment will be profitable. They, therefore, increase their total investment spending.†¨Ã¢â‚¬ ¨The concept of accelerator is not rival to the concept of multiplier. They are parallel concepts. The multiplier shows the effect of changes in autonomous investment to changes in income’ and employment. The accelerator shows the effect of changes in income to changes in induced investment. Professor Samuelson and J. R. Hicks model of multiplier accelerator offers quite satisfactory explanation of explaining turning points to business cycle.†¨Ã¢â‚¬ ¨Interactive role of multiplier and accelerator.†¨The multiplier-accelerator interaction theory of business cycle is explained now in brief. Let us assume a certain amount of autonomous investment is injected into the economy. This would generate an expansion of income many  times greater than itself on account of the operation of the multiplier mechanism. The increase in income would lead to rise in demand for consumer goods. The increase in demand for consumer goods induces more investment in the capital goods industries. The increase in investment would be much more than the increase in demand for consumer goods owing to the operation of the accelerator. The interaction of the multiplier and accelerator sets in the upswing of the trade cycle.†¨Ã¢â‚¬ ¨The rise in income and employment does not continue for a long time. The rise in income and employment progressively slows down. The reason is that the marginal propensity to consume starts declining with the rise in income in the upward swing of the business cycle. A decrease in consumption would result into a greater decrease in investment on account of reverse working of the accelerator A decrease in investment would lead to a greater decrease in income on account of the reverse working of the multiplier In short the combination of reverse working of the accelerator and multiplier sets in downward swing in the business cycle.†¨Ã¢â‚¬ ¨Interactive role of multiplier and accelerator†¨ †¨Ã¢â‚¬ ¨Ala = Increase in autonomous – investment†¨Ala = Increase in autonomous investment†¨Ay = Increase in income†¨Aid = Increase in induced investment †¨v = Size of the accelerator