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Capital stock adjustment
 

 

A theory of investment based on the capital-output ratio. Assume that firms have a target capital-output ratio. If at any time actual capital stock is less than is implied by this ratio, the firm invests so as to close part of the gap during the next period. Partial adjustment is assumed, taking account of both uncertainty and costs of adjustment.

Capital stock adjustment

As with the accelerator model, a rise in Y increases K* and thus leads to investment.

 

Reference: Oxford Press Dictonary of Economics, 5th edt.