Some Novel Implications of Replacemnt and Scrapping

The emphasis of capital theory in recent decades has moved away from the implications of useful life as an important economic variable and has turned on the microeconomic and macroeconomic consequences of investment irreversibilities. Thus the voluminous literature that has developed ignores the marked difference be-tween replacement and scrapping and glosses over their significant implications for microeconomic and aggregate dynamics. This paper highlights the gains in explana-tory power that result when useful life, replacement and scrapping are placed in the center of the analysis. It does so by considering an economy with two representative firms that differ only in that the one applies replacement and the other scrapping. Among other interesting findings, at the microeconomic level it turns out that the de-mand for replacement investment is not invariant with respect to the type of capital policy being applied, whereas at the macroeconomic level it is shown that we cannot obtain consistent aggregates of capital stock and replacement investment.