An Opportunity Cost View of Fixed Asset Theory and the Overproduction Trap: Comment

In a 1981 AJAE article, Johnson and Pasour criticize the works of Edwards and Glenn Johnson (1972 and earlier publications) for attributing persistent excess production in agriculture to an asset fixity theory which, at its crux, relies on divergences between asset acquisition costs and asset salvage values. Johnson and Pasour (MJP) pinpoint their critique of Edwards and Johnson (EJ) when they state (p. 3): "The conclusion of fixed asset theory that excess resources are 'trapped' in production can be traced directly to selection of acquisition prices of resources as a benchmark for equilibrium production. But, there is no reason to expect the opportunity cost of a resource once acquired to equal its historical acquisition price." In his 1982 AJAE reply to MJP, Glenn Johnson contends that the EJ formulation does, contrary to the MJP assertion, allocate resources on the basis of opportunity costs including the cases where opportunity cost is equal to current (not historical) acquisition cost or ourrent (not historical) salvage value. The primary purpose of this paper is to discuss briefly how MJP's article is lacking in a key respect: it ignores intertemporal opportunity costs of durable resources. To achieve brevity and expositional clarity, other aspects of differences between MJP and EJ are avoided insofar as the specifics of this paper allows. Conventional resource adjustment theory is reviewed by MJP (their equations (1)-(4), pp. 1-2). Stress is placed on the usual hypothesis that the equilibrium use of durable resources, similar to nondurables, occurs when each durable's value of marginal product just equals its marginal factor cost. This equilibrium relation is hypothesized, for a profit-maximization firm, to hold for each durable resource (or asset) in each production or planning period, t. But this engine of analysis, while acceptable for nondurable resources, lacks crucial detail for dealing with the multiperiodicity of durable resources. Essentially, it is a monoperiodic engine, or at best it is a sequential, monoperiodic engine. It avoids defining the time horizon (the finite or infinite span of t). Hence, it avoids a precise definition of the relevant set of investment/disinvestment and production activities to be considered by the decision maker. More specifically, even if t can be limited to a finite number of periods (S), intertemporal opportunity costs associated with each durable resource are ignored, assumed (by implication) to not exist, or assumed to equal zero. To paraphrase Perrin (who MJP acknowledge as having reviewed their paper), these are the costs of postponing the earnings which will be forthcoming from the series of replacement, or new-investment, durable assets for the currently owned or currently considered asset. Moreover, if the appropriate span of t is infinite, it becomes even more important not to ignore intertemporal opportunity costs. This point was illustrated conceptually by Perrin in his figure 1 (p. 61). When considering optimal investment/disinvestment in and use of durables, multiperiod models which explicitly account for time-money relationships are judged by most economic analysts to be preferable to conventional, static, monoperiodic models. Wealth maximization becomes the norm, as opposed to one-period profit maximization. Present-value equations (which model flows of acquisition prices, ensuing "quasi-rents" and salvage values of durables) or their derived first-order, marginal, optimizing inequalities take over the role of simple, static VMP-MFC equalities. In what follows, the resource adjustment rule hypothesized by MJP is compared with the marginal rules derived by Perrin (rules and logic which are presented in various earlier and subsequent texts and other publications on capital investment). Equation (3) in MJP (p. 2) summarizes their durable resource adjustment rule as follows: