Explain how the accelerator process is likely to affect economic growth. (June 2019)
Economic growth is when there is an increase in real GDP. The accelerator effect is when an increase in economic growth leads to firms increasing their level of investment. Investment is the spending on firms on capital goods, like machinery. This is because they anticipate greater demand for their goods and services, and expect to reach full capacity. Capital goods such as machinery aim to increase the productivity and the output of firms. The accelerator effect also happens because firms are more incentivised to invest when the state of the economy is good, for example in a boom. A boom has high economic growth and lower unemployment, as well as high consumer confidence. Because consumers have confidence and are spending more, firms want to take advantage to improve their processes during this time and therefore are more likely to invest, as they expect greater returns. This investment can lead to even further economic growth, which should further encourage investment.
The diagram above shows AD shifting to the right from AD to AD1 to AD2. As a result. real GDP and employment increases from y to y1 to y2 and the price level increases from PL to PL1 to PL2. This is also an example of the multiplier effect, where an initial increase in AD leads to further increases in AD.