It is ascertained that the theorem of proportionality, which maintains that replacement investment is a constant proportion of the outstanding capital stock, has several fundamental shortcomings. It derives from a model founded on assumptions that are highly restrictive and unlikely to hold in reality. It is alien to the thinking of researchers in industrial organization and other neighboring fields to economics that treat the durability of capital goods as a choice variable. It ignores several thorny conceptual and methodological issues, and, perhaps most important, it may have restrained seriously the progress towards developing models based on more realistic approaches of production. However, despite its shortcomings, the theorem continues to dominate the contemporary theory of capital, most probably because of (a) its simplicity and (b) the lack of a model that might yield a better theorem in terms of standard criteria, like explanatory and predictive power, fruitfulness, etc. For this reason, attention is drawn to recent research which shows that a model centered on the heterogeneous structure of capital and the useful lives of its components is both feasible and exceedingly rich in theoretical and empirical implications.
The Review of Austrian Economics – Springer Journals
Published: Jul 31, 2010
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