The accelerator theory states that investment is determined by the RATE AT WHICH INCOME, AND HENCE OUTPUT, CHANGES OVER TIME. The principle states simply that unless the rate of increase in consumption is maintained, the previous level of investment will not be maintained.
This theory assumes that firms try to maintain some constant relationship between the level of output and the stock of capital required to produce that output. In other words, we assume a constant capital-output ratio which can be expressed in either physical terms or money terms. The accelerator helps us to understand how small changes in demand in one sector can be magnified and spread throughout the economy. The example below assumes that the firm starts with 8 machines each year and 1 machine wears out each year and that each machine can produce 100 units of output per year. In the second year, demand rises for capital goods rises by 200% (from 1 to 3). When the rate of growth of demand for consumer goods slows in year 4, demand for capital goods falls. In year 6 demand drops and they is no requirement for any investment.
Limitations of Accelerator:
* Firms can meet output with stocks – may not need investment
* Changes in technology may mean firms don’t need to invest in as much capital as before
* Firms need to be convinced that demand is long-term to warrant investment
* Limited supply of technology available
The recent drop in oil prices from $115 per barrel in June last year to $58 per barrel today (10th March) has asked the question why don’t oil producers cut back on supply? This would seem to be the logical policy to pursue as the revenue of oil producers has been cut significantly. However Saudi Arabia has allowed big oil surpluses to grow and as a result the price has fallen. As Saudi Arabia can extract the oil from the ground at a much lower cost than its oil producing counterparts they have a greater ability to absorb the lower oil price. Those that have a high cost of extraction – US shale producers, the tarsands of Canada, Russia, Venezuela – are now finding the return from oil is much lower. Therefore, the plan being to force high costs producers out of the market leading to an increase in the market share of the Gulf states.
Excess Oil Supply
There has been a growing amount of oil in storage which is absorbing the glut. World stocks have increased by approximately 265m barrels last year and is suggested to increase by a further 1.6m-1.8m barrels a day in the first six months of 2015 which adds about 300m barrels to the total. Oil producers are hoping that the demand for oil will increase next year and that the accumulated stock will satisfy that demand. However the restocking cannot continue for long as storage facilities in Europe and Asia are already at 80-85% capacity. Companies are going as far as renting oil tankers to store the excess oil. And what happens if storage facilities start to reach full capacity, then producers will be forced to dump supply onto the market dropping the price even further. There is the belief that oil prices will drop in the long run which will mean a restructuring of the industry.
Source: The Economist February 21st 2015
Here is an image from the recent Westpac Economic Overview. As New Zealand is the world’s largest exporter of dairy products any disruption in the supply from New Zealand can impact on the global dairy prices. The last few droughts saw world dairy prices increase considerably as milk supply from the rest of the world was unable to adjust to market conditions. However supply capacity in the US and the EU has increased and with Russia’s import ban there is a much greater supply on the global market. Nevertheless, this doesn’t disprove the possibility that prices rise when supply falls short. The overall signs are that supply and demand are coming into line as Chinese buyers run down stocks. The drought in New Zealand will further boost prices from current low levels. Westpac expect the milk price to rise to $6.40/kg for the next season. Below is a useful video clip from Dominick Stephens – Chief Economist at Westpac – about the primary sector in New Zealand. It is very good on fundamentals – supply and demand.
Just been going through this part of the course with my A2 class and came across a table from some old A Level notes produced by Russell Tillson (ex Epsom College Economics and Politics Department) to help them understand the principal differences.
With euro area finance ministers meeting to discuss the Greek debt issue there has been positive news with regard to the the overall growth in the euro economy. Driven by consumption (C) and Investment (I) the German economy grew by 0.7% in the Q4 which makes the annual figure 1.4% in 2014 – see graph below. This helped the overall growth rate of the euro zone area 0.3% in Q4. The German figure is surprising when you think of the economic sanctions against Russia which has hit hard the German export market (X) – export volumes contracted 2% in Q4 in 2014. By contrast the DAX (German Stock Market indicator) recorded an all time high of 11,013 and German real wages rose 1.6% which was helped by falling oil prices.
Other euro areas didn’t do as well as their German counterparts but the important fact was that figures were more optimistic and better than expected for Q4 2014:
Source: National Australia Bank
Russia – debt looks as if it is going to be downgraded to junk status
Venezuela – is on the verge of defaulting
Brazil – growth forecast cut
Norway – significant cut in government revenue
However some other commodity exporting countries are coping with this fall in prices. Chile and Peru which are dependent on metal exports are forecast to grow 3% and 5% respectively. Furthermore no Middle Eastern country is expected to enter a recessionary phase. The Economist identifies two factors that explain why some commodity exporters are coping better with lower commodity prices.
1. Business Friendly – Many countries have made their economies more business friendly – believe it or not according to the World Bank Rwanda is a better place to do business than Italy. Benign business environments encourage foreign direct investment – Africa has encouraged FDI despite the global economic conditions.
2. Prudent Government Spending – when commodity prices were high and tax revenue was growing a lot of countries increased their expenditure significantly. However the opposite applied when prices fell as they no money to boost domestic demand.
As Keynes used to say – save when times are good and spend when times are bad.
WE THE ECONOMY website provides a series of short films that explain economic concepts or key features of the modern economy. Each of the 20 movies focuses on some aspect of the U.S. economy or on some economic concept. The films are grouped into five ‘chapters’ covering the basics of the economy:
What is the Economy?
What is Money?
What is the Role of our Government in the Economy?
What is Globalization?
What Causes Inequality?
Every 5-8 minute video is well worth watching and useful for the classroom. Below is the trailer – very professionally done and excellent reinforcement when teaching certain topics.