Machine Replacement, Network Externalities, and Investment Cycles

This paper presents a model where agents decide on the timing of replacement of ageing machines. The optimal replacement policy for an agent is influenced by other agents’ decisions because the productivity of a particular vintage displays network externalities that set in with a lag. In equilibrium, agents follow innovation cycles with a frequency that is lower than optimal, so there is too much delay. One extreme case is the possibility of inefficient collapse: for some parameters there is no investment in equilibrium, even though it is socially optimal that agents (eventually) invest in cycles. Another feature of the model is the tendency of agents to synchronize their individual decisions, and thus the outcome of the aggregate economy does not smooth out the non-convexities present at the microeconomic level. (J.E.L. Classification Numbers D92, E22, E32) This paper grew out of discussions with my advisors Russell Cooper and Douglas Gale, to whom I am immensely grateful for their comments and guidance. I have also benefited from the insighful comments of Samuel Kortum, Debraj Ray, Matilde Machado and seminar participants at the XV Latin American Meeting of the Econometric Society, NBER Summer Institute and Universities of Alicante, Carlos III (Madrid), Navarra, Nova (Lisbon), Pompeu Fabra, and Boston University. Financial support from Boston University is gratefully aknowledged. Needless to say, all remaining errors are mine. Mailing Address: Universidad Carlos III de Madrid, Departament of Economics, 28903 Getafe (Madrid), SPAIN. Tel.: +(34) 91 624 9652. Fax : +(34) 91 624 9875. e-mail: [email protected]