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A Rehabilitation of Economic Replacement Theory

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  • George C. Bitros

    (Athens University of Economics & Business)

  • Elias Flytzanis

    (Athens University of Economics & Business)

Abstract

Our objective in this paper is to shed light on the economic forces and the specific way in which they combine to determine the service life, and hence the replacement demand for durables, in the short run and in the long run. For this purpose the received multiperiod economic replacement model is extended in the light of more recent theoretical developments and solved for the number and duration of replacements. Owing mainly to the intuition that the latter decisions are inexplicably related to the owner s profit horizon, aside from steady state replacement, the model is shown to yield a range of transitional and limiting replacement policies that have been largely ignored in the literature. In addition, the results indicate that : a) the optimal service life is consistently determined by such conventional forces of short-term variation as utilization, maintenance, operating safety, interest rate, uncertainty due to technological breakthroughs, the price of new and used durables, etc., b) switching among replacement policies produces bursts or slumps in replacement investment much like the spikes discovered recently at the plant level, and c) in non- stationary economic environments the error from applying steady state replacement, instead of the more appropriate transitory replacement policies reported in this paper, may be substantial.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0303009.

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Length: 32 pages
Date of creation: 12 Mar 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0303009

Note: Type of Document - Acrobat PDF; prepared on IBM PC - PC; to print on HP/PostScript; pages: 32 ; figures: included. Acrobat PDF document submitted via ftp. Abstact and figures included.
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Web page: http://128.118.178.162

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Keywords: service life; replacement; and scrapping;

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References

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  1. Thomas F. Cooley & Jeremy Greenwood & Mehmet Yorukoglu, 1994. "The replacement problem," Discussion Paper / Institute for Empirical Macroeconomics 95, Federal Reserve Bank of Minneapolis.
  2. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
  3. John Haltiwanger & Russell Cooper & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September.
  4. Morton I. Kamien & Nancy L. Schwartz, 1971. "Optimal Maintenance and Sale Age for a Machine Subject to Failure," Management Science, INFORMS, vol. 17(8), pages B495-B504, April.
  5. Malcomson, James M., 1975. "Replacement and the rental value of capital equipment subject to obsolescence," Journal of Economic Theory, Elsevier, vol. 10(1), pages 24-41, February.
  6. John Rust & Geoffrey Rothwell, 1995. "On the Optimal Lifetime of Nuclear Power Plants," Industrial Organization 9512002, EconWPA, revised 15 Dec 1995.
  7. Arnott, Richard & Davidson, Russell & Pines, David, 1983. "Housing Quality, Maintenance and Rehabilitation," Review of Economic Studies, Wiley Blackwell, vol. 50(3), pages 467-94, July.
  8. Russell Cooper & John Haltiwanger, 1990. "The Aggregate Implications of Machine Replacement: Theory and Evidence," NBER Working Papers 3552, National Bureau of Economic Research, Inc.
  9. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  11. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
  12. Westin, Richard B, 1975. "Empirical Implications of Infrequent Purchase Behavior in a Stock Adjustment Model," American Economic Review, American Economic Association, vol. 65(3), pages 384-96, June.
  13. Mauer, David C. & Ott, Steven H., 1995. "Investment under Uncertainty: The Case of Replacement Investment Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 581-605, December.
  14. Wykoff, Frank C, 1973. "A User Cost Approach to New Automobile Purchases," Review of Economic Studies, Wiley Blackwell, vol. 40(3), pages 377-90, July.
  15. Feldstein, Martin S & Foot, David K, 1971. "The Other Half of Gross Investment: Replacement and Modernization Expenditures," The Review of Economics and Statistics, MIT Press, vol. 53(1), pages 49-58, February.
  16. Wykoff, Frank C, 1970. "Capital Depreciation in the Postwar Period: Automobiles," The Review of Economics and Statistics, MIT Press, vol. 52(2), pages 168-72, May.
  17. Bond, Eric W, 1983. "Trade in Used Equipment with Heterogeneous Firms," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 688-705, August.
  18. Nickell, Stephen, 1975. "A closer look at replacement investment," Journal of Economic Theory, Elsevier, vol. 10(1), pages 54-88, February.
  19. Gerald L. Thompson, 1968. "Optimal Maintenance Policy and Sale Date of a Machine," Management Science, INFORMS, vol. 14(9), pages 543-550, May.
  20. Smith, R P, 1974. "A Note on Car Replacement," Review of Economic Studies, Wiley Blackwell, vol. 41(4), pages 567-70, October.
  21. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  22. van Hilten, Onno, 1991. "The optimal lifetime of capital equipment," Journal of Economic Theory, Elsevier, vol. 55(2), pages 449-454, December.
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