[OPE -L] Historical Costs

John R. Ernst (ernst@PIPELINE.COM)
Fri, 23 Jan 1998 02:29:02 -0500 (EST)

One of the difficulties in following the discussion
between Andrew and Fred is my lack of understanding
of Marx's notion of "moral depreciation." If we
define the total depreciation between any two periods
as the difference in the present values of the fixed
capital, I do think we can gain greater clarity.
Further, while this allows us to look at the rate of
profit, it will also enable us to consider what the
capitalists of today use to measure profitability --
the rate of return.

Simple Depreciation.

Let's assume that the initial capital invested is all fixed
capital and that the annual payment expected on this investment
is $500. Assuming a rate of return of 10%, we obtain the
Table I

Capital Economic Annual Machine after
Advanced Depreciation Profit Payment Period

1 $2,178 $282 $218 ----> $500 $1,895
2 $1,895 $455 $45 ----> $500 $1,441
3 $1,441 $413 $87 ----> $500 $1,028
4 $1,028 $376 $124 ----> $500 $652
5 $652 $342 $158 ----> $500 $310
6 $310 $310 $190 ----> $500 $0

Totals $2,178 $822 $3000

Note that in each and every period, the capitalist is earning
a return of 10%. However, the capitalist can easily see that
the rate of profit varies as depreciation takes place. Further,
any capitalist would anticipate earning the same rate of return
if he bought a new machine or a used machine at the end of
periods 1-5. We assume that the machine is scrapped at the
end of the sixth period and that its scrap value is 0.

One Type of "Moral Depreciation"

Now let's simply assume that the expected payment drops from
by $10 after each of the periods 2-6. After the machine
has been "used up" at the end of the 6 periods, we and the
capitalist can compute his rate of return -- 8.4%. Note that
all we know of the "newer" techniques that caused this $10
price decrease at the end of periods 2-6 is that they had
the effect of lowering the price of the output by that amount.

Table II

Capital Economic Annual Machine after
Advanced Depreciation Profit Payment Period

1 $2,178 $316 $184 ----> $500 $1,861
2 $1,861 $452 $38 ----> $490 $1,410
3 $1,410 $408 $72 ----> $480 $1,001
4 $1,001 $369 $101 ----> $470 $633
5 $633 $333 $127 ----> $460 $300
6 $300 $300 $150 ----> $450 $0

Totals $2,178 $672 $2,850

Clearly, the rate of profit on the capital invested in any period
is greater in Table I than in Table II. The rate of return falls
from 10% to 8.4%. The capitalist measures his return on the
investment he made at the beginning of period 1. Note that at the
end of each period, the capitalist could not sell the machine for
the "price" after that period given that the newer machines that
forced the payment for the output to drop are earning a rate of
return higher than 8.4% -- perhaps 10% or more.

As we move from Table I to Table II, we see that the total value
of the output declines, the total cost of the investment is still
equal to the amount recovered as depreciation and the amount of
profit decreases. Hence the fall in the rate of return.

When it comes to simultaneous valuation, I am unclear what we are
to tell the capitalist.

a. You did not invest what you said you did.

b. You should not have invested but rather anticipated the
decreases in the annual payment and thereby determined
that the investment would not yield the 10% you thought it

c. You should have sold out at the end of 1st period. Let the
others take the lower annual payments.

d. All of the above.

"a" is clearly absurd.

"b" seems to demand perfect information. This is not to say that
the capitalist is unable to anticipate falls in the price of his
output. Here, we merely discuss the case where it is

"c" simply passes off the decrease in the rate of return from
one capitalist to another.


By not expressing the initial investment in labor hours but in
money, simultaneous valuation runs into considerable difficulty.
You can't invest one sum of money at the beginning of a period
and be told that the rate of return must be measured on some
other amount derived after production takes place. In other
words, as both Duncan and David Laibman indicated at the EEA
last year, simultaneous valuation does have difficulty
when it comes to asset revaluation. Granted there are more
cases to consider than this simple one. However, to not
consider this problem as those locked into simultaneous
valuation often do is to ignore something very basic
in capitalism -- you make profits on what you actually
invested, not on some amount derived from the process of
simultaneous valuation.