Re: (OPE-L) Ajit's paper (costs)

From: Phil Dunn (pscumnud@DIRCON.CO.UK)
Date: Sat Jun 12 2004 - 03:25:47 EDT

Hi Ajit

This is the argument set out in a table.

The figures are in dollars.  The firm produces the same number of
products in the same way in every period, using the same inputs.
Historical costs double from period from period 1 to period 2, and
double again from period 2 to period 3.  After that they are
constant.  Replacement costs are the historical costs of the
following period.  Workers live on air, but clearly this assumption
does not matter.  Revenue doubles when historical costs double.  The
production process starts off afresh every period: there is nothing
carried over from period to period.  The firm has no difficulty
borrowing the money to buy inputs and can repay the loan at end of
period.  The firm is small in relation to the whole economy and stays
small.  The effect of the price rises on inflation is therefore
negligible.  The rate of inflation differs negligibly from zero.
(Increases in productivity are thought by some to increase inflation.
Consequently, labour productivity is held constant.)

Period          Historical      Replacement  Revenue    HC Profit
        RC profit       Cash Pile
        Costs   Costs

0       100     100         150   50      50        0

1       100     200         150   50    -50     100

2       200     400         300 100     -100    300

3       400     400         600 200       200   300

4       400

The cash pile accumulates when RC profits falls below HC profits.

Conclusion: Replacement cost accounting is wrong when inflation is zero.

Thesis: Historical cost accounts should only be adjusted for changes
in the value of money.  Any price changes that remain after this
adjustment are changes in value.


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