Question

briefly explain how the stock of manufactured capital changes over time: be sure to discuss investment and depreciation and be sure to use the “bathtub” model to illustrate the stock of manufactured capital. Explain why the Bureau of Economic Analysis defines depreciation at the consumption of fixed capital.

Answer 1

Manufactured Capital comprises wholly of physical man-made stock, which is produced and reproduced by society and contributes to the production process rather than being the output itself. It has structural and functional dimensions. In economic terms, capital has a cost in terms of investment flows and depreciation. Depreciation is a measure of the decline in the value of a fixed asset over time due to wear and tear, obsolescence, etc. While investment is the expenditure on capital stock over time. Gross investment less depreciation measures the actual value of the capital stock (net investment). Positive net investment is an indicator that productive capacity is increasing. Depreciation reduces the stock of fixed assets, while investment replenishes or increases it.

Bath tub model

The amount of water in the tub at any given time is representative of the stock of manufactured capital. A critical mass of capital  stock is necessary for unit effectiveness (i.e., insufficient quantity of water in the the tub makes it impossible to get clean). The water coming into the tub through the faucet and out of the tub through the drain represent the flows of the capital and influence the stock of capital and whether the critical mass is achieved and sustained.

Economically speaking, depreciation can be understood as a deduction from income which is responsible for the loss in capital value owing to the use of capital goods in production. This specific interpretation of the value loss in production explains why consumption of fixed capital is synonymous for depreciation.