Optimal Obsolescence Driven by Technological Change

Technological change is examined in a model of capital production to show that “creative destruction” can occur as an outcome of firm’s optimizing behavior. Capital systems are made up of components that are necessary for them to operate and that have uncertainty with respect to durability. For each type of technological change agents make a corresponding decision about whether to continue to use the original capital system (if it is still alive) or to scrap it and build a new capital system which embodies the new technology. Each system has transitional probabilities for scrapping that depend on the size of the present value of the vintage. As technology improves, the optimizing level of durability and thus the optimal stock of embodied services increases for the new capital system. Yet simultaneously the probability of scrapping an old system over any given time interval increases. Thus, the larger is the improvement in technology, the greater is the chance of scrapping the old system before its physical service life has ended. Over some time horizon of unforeseen and rapid technological change investment in new capital systems could be increasing while at the same time old capital systems are scrapped at a faster rate.