Optimal Replacement Under Variable Intensity of Utilization and Technological Progress

ABSTRACT

We presented two modifications of the traditional model of optimal replacement of capital equipment. Starting from cost-minimization over an infinite horizon, we introduced a variable intensity of utilization in the traditional replacement model to explain functional degradation, i.e., the reduction in utilization intensity as equipment ages. Next, we demonstrated that when technological progress is ongoing, the basic model of optimal replacement can give erroneous results due to neglecting the opportunity cost of foregone technological progress at the time of replacement.