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hi guys welcome to the economic circle I'm dr. Alex Mosley today I'm in my garden recording this it's a beautiful mid spring this morning in England the Midlands a little bit cool when the wind blows up hence my chilly or jacket whatever you call it and in this issue in this article what I'll be doing is introducing the accelerator theory this is part of a series I'll be rolling out on the A to Z of basic concepts in economics if there's anything you want to hear about or learn about send a note on the YouTube video below or email directly on info at economic circle dr. Coates or info at econ circle Co I'll put that in a message below and just let me know if there's anything you want to hear okay you'll be hearing bird noise as I record this because they're out and it's spring time okay thanks for listening guys see you later bye hi this is the analysis of the accelerator theory part of our series that we'll be building up on the 8 a set of basic economic concepts now the basic idea here is that the accelerator Theory investments is an attempt to explain what happens when consumer demand for a product increases and its effect on the capital goods industry and how that may also relate to business cycles that we experience we'll be looking at the basic mechanism and then examine what may be wrong with the theory now the model begins by assuming that a company has a fixed number of machines in operation and is selling a similar amount of produce yearly it then experiences an increase in demand for its producer which necessitates an increase in capital investment to produce the good make sense this increased quantity of machine purchases is however according to the accelerator theory a magnified percentage of the increased quantity in demand so let's go through a numerical example this is the sort of thing that you get examined on in economics courses and that you should be able to replicate them as the multiple choice or short answers so imagine a factory producing a hunt a thousand cars a year with X amount of engineers and ten machines now it's interesting that the quantity of laborers is not part of what we're looking at in this model they're assumed fixed which is interesting now each machine is therefore capable of contributing to the production of a hundred cars make sense thousand divided by 10 is 100 now one machine is to be replaced annually so capital demand runs at one machine per year and this is the important aspect of this that one machine is being demanded each year to replace the one that's just being depreciated so comp reduce any more cars now let's assume that demand for cars increases to 1,200 a year this represents a 20 percent increase in consumer demand but the demand for machines increases from one machine in the ER to an extra two machines to help produce the extra cars rights required by the marketplace the mathematical essence of the accelerator theory can thus be shown so the increase in the capital goods demand it goes from 1 to 3 which represents a 200% increase a 200% increase in capital goods demand for that yeah however if we assume that demand remains stable at 1200 after that the company will return to its normal replacement rate of one machine per year and so capital goods demand will fall from 3 machines back down to 1 so during a quick calculation this represents a 66 percent decrease in capital goods demand Lu accordingly from what we see from the accelerate model capital investment demand has been catapulted from one machine year through a 200% increase in demand from about sixty percent decrease in demand now these fluctuations supporters of the theory argue cause the crises that we witness in modern economies I the business cycle so here's a quick graph showing that that both consumer demand and capital goods demand are going at zero percentage change each year now certainly it's a little blip in consumer demand 20 percent though this is obviously not to scale this necessitates a 200% increase in capital goods demand fall in the which as consumer demand follows down to a zero percent increase the following year capital goods demand drops 66% before they return to normal zero percent changes the year afterwards whoa this is the accelerator model that there's been an acceleration in the demand for capital goods make sense so far right now before we look at the problems done to Durham a note from the sponsors I the economic circle my company if you check out Apple newsstand or Google Play you'll find out monthly digital magazine in that magazine we cover 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most of economics we're very flexible as to what the time period is we look at the short-run and long-run but we're not using accounting terms we're using arbitrary periods or flexible pairs that are dependent on the industry accordingly the time period we should be looking at with this industry is 10 years that is let's say the life cycle of the Machine of a single machine rather than looking at a single yeah in that case when we redo the figures then the increase in capital demand and she drops back down into line with the increase in consumer demand for the cars in other words it's not that exciting secondly there's no slack assumed in the system that most companies can cope with an increase in demand as they tend not to run at 100% capacity all the time also we can offer overtime to the engineers to work extra hours and use the machines that they do have for longer periods instead of working 9:00 to 5:00 work until 6:00 or 7:00 paying them accordingly similarly this is a common to come back to entrepreneurs in the company have to ascertain whether the increase in demand is actually permanent or temporary hmm thirdly because about the accelerator model presumes that the entrepreneurs reacting wildly to a demand signal they run out and buy capital goods and that they do not change the prices of the cars was an increase in demand what normally happens with them is an increase in demand we've got the prices up and the entrepreneurs are not looking ahead to assess whether the increase in capital expenditure is actually worth it to them so in many respects the model is what we call mechanistic it's almost like no disrespect to engineers but an engineers or a physicists view of markets sort of a static view whereas entrepreneurs are aware that changes in demand can be temporary and that their success as entrepreneurs is dependent on reading markets and the movements rather than just reacting to what's happening immediately fourthly the theory engages in a common fallacy in economics that what happens to single firm must be happening to the entire economy now this is just a complete logical fallacy to silly right microeconomics an Austrian theorists are very good at exploding this myth this fallacy and reviewing it emphasizing the interconnectedness of markets for example if a company if the fart of the the car company experiences an increase in demand customers may be simultaneously reducing their demand for other products for example holidays abroad for that year accordingly the expansion and capital investment in the car industry or the car company will occur with the decrease in investment going into the holiday industry there's just a shift of resources right the only way that both industries could experience an increase in calculus is for purchases of other consumer goods to fall in order to increase the savings or the retained profits in the industries to finance the capital purchases in other words if there's going to be an increase in the capital stock we must give up something now this is basic economics but it's often forgotten especially models like the accelerator theory or Keynesian economics where there sooner see consumption can just increase how what are you giving up when you give it up savings or savings can increase it the same times consumption not really fifthly the model also assumes that capital goods can be produced instantaneously this is a very strange I unrealistic assumption a kid two people playing the game of Monopoly and wanted to buy a hotel well here you go says the banker here's your hotel as instantaneous but in reality capital goods may take a while to acquire hence economists description of the short versus long run is flexible for example a computer operator somebody running a server or whatever or web design company can run down to a local computer store and set up with a new computer within an era so that's their long run Wow but a car factory may have to wait several months for a new machine to be built again this underlines the Arbitron us of just using one year time period in the theory of the model as well as the assumption of entrepreneur has been reactive rather than entrepreneurial again very mechanistic and quite unrealistic finally as for being an explanation of the business cycle it it completely ignores the monetary sector the mantra effects and alterations in the interest rates real interest rates if you were by central banks and the entire edifice of modern military pyramids ie fractional reserve banking it's almost as if it's missing the elephant in the room or look at this increase in capital demand it's very interesting isn't it that everything's Poisson is well a catchy interest rates have dropped and there's a huge amount of credit be increased and banking system I'm not interested in that well if you're not interested now you're not doing economics you're not connecting markets together and looking at the multi effects of credit creation and that's where really the business cycle comes from anyway accordingly the focus of the accelerate accelerate model is more on the symptoms rather than causes arguably it's description of the symptoms fails and therefore of the causal theory of the business cycle fails just as mechanistic theories of physiology fail the mechanistic accelerator Theory fails - this is an analogy the market like the body is organic and constantly adapting to its environment but unlike the body entrepreneurs in the marketplace forward-looking as well as innovative and experimental and this makes economics much more interesting than simple mechanistic theories make sense right here follows an advertisement for the economics Circle magazine which is online through Apple newsstand and Google+ plate thanks for listening guys enjoy the videos bye now