An Analysis of the Dynamics of the Vintage Capital

Master Thesis by Lijia Mo
July 6, 2005

Abstract

Why does the vintage capital explain well the economic inequality? The technology shock will lead to new unemployment. This paper wants to give a numerical analysis of the vintage model to reveal this fact. In the vintage capital model the economy can not replace all its old capital at each date, instead they renew their capital step by step, and different technologies exist at the same time. If different technologies reside in production tools and the plant and its labor can use just one technology at a time, a variety of productive tools will be in use at the same time, since each worker uses different vintage production tools therefore laborís productivities will differ. This vintage capital incurred inequality can be used to explain today huge inequality in per capita outputs among countries. Income disparity is not a consequence of different initial conditions, but the result of different investment choices made by each economy. This paper attempts to explore the route how do aggregate shocks affect aggregate employment by changing the fraction of plants that choose to adjust. The neutral technological shocks increase job reallocation and reduce aggregate employment. The increasing adjustment hazard influences the job reallocation by affecting the marginal product of capital for all vintages, therefore the capital flows from the updated sector 0 to old sector 1. Then labor forces in the old sector with old technology are endowed with more capital, which boosts their relative wages, the labor forces in old sector will increase. Aided with the endogenous adjustment ratios, the previous vintage model gets a new explanation. Empirical study results demonstrate the strongly positive correlation between GNP and private fixed investment of the United State data during the period from 1974 quarter 1 to 2004 quarter 2. There is an investment-driven business cycle in the United State case. In line with this fact, economic policy should pique growth through technology and capital intensity two channels. The policy maker should also impose strength on boosting national savings as well as translating savings to productive investments and enhance the level of education.