A Rehabilitation of Economic Replacement Theory

Athens University of Economics and Business, Economics Discussion Paper No. 145

31 Pages Posted: 14 Apr 2003

See all articles by Georgios (George) C. Bitros

Georgios (George) C. Bitros

Athens University of Economics and Business - Department of Economics

Helias (Elias) Flytzanis

Athens University of Economics and Business - Department of Informatics

Date Written: September 2002

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 multi-period 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.

Keywords: replacement demand for durables, transitional and limiting replacement and scraping polcies,replacement spikes and switcing among replacement policies, determinants of replacement investment

JEL Classification: E22

Suggested Citation

Bitros, Georgios (George) C. and Flytzanis, Helias (Elias), A Rehabilitation of Economic Replacement Theory (September 2002). Athens University of Economics and Business, Economics Discussion Paper No. 145, Available at SSRN: https://ssrn.com/abstract=327980 or http://dx.doi.org/10.2139/ssrn.327980

Georgios (George) C. Bitros (Contact Author)

Athens University of Economics and Business - Department of Economics ( email )

76 Patission Street
Athens, 10434
Greece
030 210 8203740 (Phone)
030 210 8070545 (Fax)

Helias (Elias) Flytzanis

Athens University of Economics and Business - Department of Informatics ( email )

76 Patission Street
GR-10434 Athens
Greece