2. Supporters of accelerated depreciation in 1981 acknowledged that it favored h

Question

2. Supporters of accelerated depreciation in 1981 acknowledged that it favored heavy industry ("smokestack America") but argued that this was desirable. Why do economist tend to look askance at such arguments? Can you identify any major market failures? If it were decided to subsidize these industries, in what other ways might it be done?

3. In the debate concerning repeal of the provision allowing capital gains on assets passed on to one’s heirs to escape taxation, some have reasoned that death is not voluntary, and therefore one should not tax capital gains upon death. Evaluate

Explanation / Answer

2) Dear sir/madam, the distinction between gross and net investment is essential even though the difference, depreciation, is hard to measure.Using the bathtub metaphor, the flow from the faucet is gross investment and the water down the drain is depreciation. The difference between inflow and outflow ( gross investment less depreciation) is net investment. Aggregate supply depends on net investment, since in the long run net investment determines the capital stock. Aggregate demand, in contrast, depends on gross investment= a job building an additional machine or building a replacement is still a job.

Depreciation is more than just the physical wear and tear that results from use and age. A piece of capital may become economically obsolete, for instance, because input prices change= as gas-guzzlers become obsolete when oil prices increased. Economic depreciation may be more rapid than physical depreciation. Technological obsolescence may also cause rapid economic depreciation. This is particularly true of computers, for which quality improvements have become dramatic.

The rate of depreciation depends on the type of capital. eg- structures have a useful life of decades, while office equipment has a life of only a few years. This has an important implication : If investment shifts toward capital goods with a short life ( eg. computers) then those gods make up a larger share of the capital stock, and , as a result, the overall rate of depreciation will rise. This is what happened in the US starting in the 1980s,

2) Although it is traditional, the focus on private sector additions to the capital stock takes a too-restricted view of investment in two aspects. First, it ignores government investment. As anyone who attends a public school or travels on the public highways can tell, government investment also contributes to economic productivity. There has been much recent work on the productivity of government capital, and there is no question that government investment should be included in aggregate investment. Estimates are that the government investment should be included in aggregate investment. Estimates are that govt. capital stock is about 15 to 20 percent of the private capital stock, therefore, the US capital stock and investment are 15 to 20 percent larger from common magnitudes.

Second, individuals invest not only in physical capital but also in human capital, in increasing the productive capacity of people, through schooling and training. The late Robert Eisner of Northwestern University estimated that the stock of human capital in the US is almost as large as the stock of physical capital. There is much evidence that this investment, like that in physical capital ,yields a positive real return, indeed , the return on human capital typically exceeds that on physical capital.

In thinking about investment as spending that increases future productivity, one should look beyond just private sector gross investment.

By,

Nishant Bhatt

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