Because the level of investment depends upon the rate of change of GNP, when GNP is rising rapidly then investment will be at a high level, as producers seek to add to their capacity (time t in Fig.
The combined effect of accelerator and multiplier forces working through an investment cycle has been offered as an explanation for changes in the level of economic activity associated with the BUSINESS CYCLE. A rise in induced investment, in turn, serves to reinforce the MULTIPLIER effect in increasing national income. Investment is thus, in part, a function of changes in the level of income: I = f(AY). If demand increases by 20%, it must invest in two new machines to accommodate that demand in addition to the one replacement machine. By way of simple illustration, let us suppose a business meets the existing demand for its product, utilizing 10 machines, one of which is replaced each year.
A rapid rise in income and consumption spending will put pressure on existing capacity and encourage businesses to invest, not only to replace existing capital as it wears out but also to invest in new plant and equipment to meet the increase in demand. accelerator the relationship between the amount of net or INDUCED INVESTMENT (gross investment less REPLACEMENT INVESTMENT) and the rate of change of NATIONAL INCOME. The graph shows how gross national product and the level of investment vary over time.
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