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A Rehabilitation of Economic Replacement Theory

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Author Info
George C. Bitros (Athens University of Economics & Business)
Elias Flytzanis (Athens University of Economics & Business)

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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<92>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 <93>spikes<94> 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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Paper provided by EconWPA in its series Macroeconomics with number 0303009.

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

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Related research
Keywords: service life; replacement; and scrapping;

Find related papers by JEL classification:
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity

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  1. 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. [Downloadable!] (restricted)
  2. Russell Cooper & John Haltiwanger, 1993. "The Aggregate Implications of Machine Replacement: Theory and Evidence," NBER Working Papers 3552, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Nickell, Stephen, 1975. "A closer look at replacement investment," Journal of Economic Theory, Elsevier, vol. 10(1), pages 54-88, February. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
  6. 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. [Downloadable!] (restricted)
  7. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. 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. [Downloadable!]
  9. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November. [Downloadable!] (restricted)
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  10. van Hilten, Onno, 1991. "The optimal lifetime of capital equipment," Journal of Economic Theory, Elsevier, vol. 55(2), pages 449-454, December. [Downloadable!] (restricted)
  11. Smith, R P, 1974. "A Note on Car Replacement," Review of Economic Studies, Blackwell Publishing, vol. 41(4), pages 567-70, October. [Downloadable!] (restricted)
  12. Arnott, Richard & Davidson, Russell & Pines, David, 1983. "Housing Quality, Maintenance and Rehabilitation," Review of Economic Studies, Blackwell Publishing, vol. 50(3), pages 467-94, July. [Downloadable!] (restricted)
  13. 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. [Downloadable!] (restricted)
  14. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Timothy Dunne, 1994. "Plant Age and Technology Use in US. Manufacturing Industries," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 488-499, Autumn. [Downloadable!] (restricted)
  16. Wykoff, Frank C, 1973. "A User Cost Approach to New Automobile Purchases," Review of Economic Studies, Blackwell Publishing, vol. 40(3), pages 377-90, July. [Downloadable!] (restricted)
  17. Rothwell, Geoffrey & Rust, John, 1997. "On the Optimal Lifetime of Nuclear Power Plants," Journal of Business & Economic Statistics, American Statistical Association, vol. 15(2), pages 195-208, April.
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  18. Russell Cooper & John Haltiwanger & 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. [Downloadable!] (restricted)
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  19. 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. [Downloadable!] (restricted)
  20. 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(1995-2), pages 1-54. [Downloadable!]
  21. Thomas F. Cooley & Jeremy Greenwood & Mehmet Yorukoglu, 1994. "The replacement problem," Discussion Paper / Institute for Empirical Macroeconomics 95, Federal Reserve Bank of Minneapolis. [Downloadable!]
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