11.18. The Fallacy of the Acceleration Principle

0:0018. The Fallacy of the Acceleration Principle The Acceleration Principle has been adopted by some Keynesians as their explanation of investment, then to be combined with the multiplier to yield various mathematical models of the business cycle. The Acceleration Principle antedates Keynesianism, however, and may be The essence of the acceleration principle may be summed up in the following illustration. Let us take a certain firm or industry, preferably a first-rank producer of consumers' goods.

0:50Assume that the firm is producing an output of 100 units of a good during a certain period of Time and that 10 machines of a certain type are needed in this production. If the period is a year, consumers demand and purchase 100 units of output per year. The firm has a stock of 10 machines. Suppose that the average life of a machine is 10 years. In equilibrium, the firm buys one machine as a replacement every year, assuming it had bought a new machine every year to build up to 10. It is usually overlooked that this replacement pattern necessary to the acceleration principle could apply only to those firms or industries that had been growing in size rapidly and continuously.

1:46Now suppose that there is a 20% increase in the consumer demand for the firm's output. Consumers now wish to purchase 120 units of output. Assuming a fixed ratio of capital investment to output, it is now necessary for the firm to have 12 machines, maintaining the ratio of 1 machine to 10 units of annual output. In order to have the twelve machines, it must buy two additional machines this year. Add this demand to its usual demand of one machine, and we see that there has been a 200% increase in demand for the machine.

2:33A 20% increase in demand for the product has caused a 200% increase in demand for the capital good. Hence, say the proponents of the Acceleration Principle, an increase in consumption demand in general causes an enormously magnified increase in demand for capital goods, or rather it causes a magnified increase in demand for fixed capital goods of high durability. Obviously, capital goods lasting only one year would receive no magnification effect. The essence of the acceleration principle is the relationship between the increased demand and the low level of replacement demand for a durable good.

3:27The more durable the good, the greater the magnification, and the greater, therefore, the acceleration effect. Now suppose that in the next year consumer demand for output remains at 120 units. There has been no change in consumer demand from the second year when it changed from 100 to 120 to the third year. And yet, the accelerationists point out, dire things are happening in the demand for fixed capital. For now, there is no longer any need for firms to purchase any new machines beyond what is necessary for replacement. Needed for replacement is still only one machine per year.

4:17As a result, while there is zero change in demand for consumers' goods, there is a 200% decline in demand for fixed capital, and the former is the cause of the latter. In the long run, of course, the situation stabilizes into an equilibrium with 120 units of output and one unit of replacement. But in the short run, there has been consequent upon a simple increase of 20% in consumer demand. First, a 200% increase in the demand for fixed capital, and next, a 200% decrease. To the upholders of the Acceleration Principle, this illustration provides the key to some of the main features of the business cycle, the greater fluctuations of fixed capital goods industries as compared with consumers goods, and the mass of errors revealed by the crisis in the investment goods industries.

5:24The Acceleration Principle leaps boldly from the example of a single firm to a discussion Transformation of Aggregate Consumption and Aggregate Investment Everyone knows, the advocates say, that consumption increases in a boom. This increase in consumption accelerates and magnifies increases in investment. Then, the rate of increase of consumption slows down, and a decline is brought about in investment in fixed capital. Furthermore, if consumption demand declines, then there is excess capacity in fixed capital, another feature of the depression.

6:09The acceleration principle is rife with error. An important fallacy at the heart of the principle has been uncovered by W. H. Hutt. We have seen that consumer demand increases by 20 percent, but why must two extra machines must be purchased in a year. What does the year have to do with it? If we analyze the matter closely, we find that the year is a purely arbitrary and irrelevant unit, even within the terms of the example itself. We might just as readily take a week as the period of time. Then we would have to say that consumer demand, which after all goes on continuously, increases 20% over the first week, thereby necessitating a 200% increase in demand for machines in the first week, or even an infinite increase if the replacement does not precisely occur in the first week, followed by a 200% or infinite decline in the next week, and stability thereafter.

7:23A week is never used by the accelerationists, because the example would then be glaringly inapplicable to real life, which does not see such enormous fluctuations in the course of a couple of weeks. But a week is no more arbitrary than a year. In fact, the only non-arbitrary period to choose would be the life of the machine, for example, ten years. Over a 10-year period, demand for machines had previously been 10 in the previous decade, and in the current and succeeding decades, it will be 10 plus the extra 2, that is, 12.

8:09In short, over the 10-year period, the demand for machines will increase precisely in the Since businesses buy and produce over planned periods covering the life of their equipment, there is no reason to assume that the market will not plan production suitably and smoothly without the erratic fluctuations manufactured by the model of the acceleration principle. There is in fact no validity in saying that increased consumption requires increased production of machines immediately.

8:56On the contrary, it is only increased saving and investment in machines at points of time chosen by entrepreneurs strictly on the basis of expected profit that permits increased Production of Consumers' Goods in the Future. Secondly, the Acceleration Principle makes a completely unjustified leap from the single firm or industry to the whole economy. A 20% increase in consumption demand at one point must signify a 20% drop in consumption somewhere else. Or how can consumption demand in general increase?

9:44Consumption demand in general can increase only through a shift from saving. But if saving decreases, then there are less funds available for investment. If there are less funds available for investment, how can investment increase even more than consumption? In fact, there are less funds available for investment when consumption increases. Consumption and investment compete for the use of funds. Another important consideration is that the proof of the acceleration principle is couched in physical rather than monetary terms. Actually, consumption demand, particularly aggregate consumption demand, as well as demand for capital goods, cannot be expressed in physical terms.

10:41It must be expressed in monetary terms, since the demand for goods is the reverse of the supply of money on the market for exchange. If consumer demand increases either for one good or for all, it increases in monetary terms, thereby raising prices of consumers' goods. Yet we notice that there has been no discussion whatever of prices or price relationships in the acceleration principle. This neglect of price relationships is sufficient by itself to invalidate the entire principle. The neglect of prices and price relations is at the core of a great many economic fallacies.

11:29The acceleration principle simply glides from a demonstration in physical terms to a conclusion in monetary terms. Furthermore, the acceleration principle assumes a constant relationship between fixed capital and output, ignoring substitutability. The possibility of a range of output, the more or less intensive working of factors. It also assumes that the new machines are produced practically instantaneously, thus ignoring the requisite period of production. In fact, the entire acceleration principle is a fallaciously mechanistic one, assuming automatic reactions by entrepreneurs to present data, thereby ignoring the most important fact about entrepreneurship, that it is speculative, that its essence is estimating the data of the uncertain future.

12:34It therefore involves judgment of future conditions by businessmen, and not simply blind reactions to past data. All entrepreneurs are those who best forecast the future. Why can't the entrepreneurs foresee the supposed slackening of demand and arrange their investments accordingly? In fact, that is what they will do. If the economist, armed with knowledge of the acceleration principle, thinks that he will be able to operate more profitably than the generally successful entrepreneur, why Why does he not become an entrepreneur and reap the rewards of success himself? All theories of the business cycle attempting to demonstrate general entrepreneurial error on the free market, founder on this problem.

13:29They do not answer the crucial question, why does a whole set of men, most able in judging the future, suddenly lapse into forecasting error? A clue to the correct business cycle theory is contained in the fact that buried somewhere in a footnote or minor clause of all business cycle theories is the assumption that the money supply expands during the boom, in particular through credit expansion by the banks. The fact that this is a necessary condition in all the theories should lead us to explore for this factor further. Perhaps it is a sufficient condition as well. But, as we have seen, there can be no bank credit expansion on the free market, since this is equivalent to the issue of fraudulent warehouse receipts. The positive discussion of business cycle theory will have to be postponed to the next chapter, since there can be no business cycle in the purely Business cycle theorists have always claimed to be more realistic than general economic theorists.

14:47With the exceptions of Mises and Hayek correctly, and Schumpeter fallaciously, none has tried to deduce his business cycle theory from general economic analysis. It should be clear that this is required for a satisfactory explanation of the business cycle. Some, in fact, have explicitly discarded economic analysis altogether in their study of business cycles, while most writers use aggregate models with no relation to a general economic analysis of individual action. All of these commit the fallacy of conceptual realism, that is, of using aggregative concepts and shuffling them at will, without relating them to actual individual action while believing that something is being said about the real world.

15:42The business cycle theorist pours over sine curves, mathematical models and curves of all types. He shuffles equations and interactions and thinks that he is saying something about the economic system or about human action. In fact, he is not. The overwhelming bulk of current business cycle theory is not economics at all, but meaningless manipulation of mathematical equations and geometric diagrams.