Assumption Of Perfect Substitutability Research Articles

Sustainability and comprehensive wealth accounting: the case of India

The criterion of non-declining comprehensive wealth per capita used to determine sustainability of economic growth indicates that growth in most countries is weakly sustainable, as decline in natural capital is more than offset by increase in anthropogenic capital. This paper examines the sustainability of economic growth in India by estimating the trend in comprehensive wealth during 1975–2013, utilizing recent remote sensing native forest cover data in order to obtain more accurate valuation of natural capital. This is the first study to construct wealth estimates for a period spanning four decades, apart from adopting hybrid methodology for estimating certain wealth components such as subsoil assets. We find that the composition of India’s wealth is biased toward produced capital, although given the large working-age population, India holds immense potential for human capital building. The quality of natural capital is also deteriorating due to increasing carbon emissions and particulate pollution. Although we find that growth in India is weakly sustainable, it is based on the assumption of perfect substitutability of different capital forms, which is questionable. Loss of natural forests and accompanying native biodiversity raises serious concerns of the threat it poses to future generations. Our sensitivity analysis based on variation in the discount rate also suggests cautious use of natural resources.

The asymmetric impact of human capital on economic growth

This paper re-examines the effect of human capital on countries’ economic growth paths. It investigates the significance and the asymmetric impact of human capital stock on economic growth. We apply both a nonparametric and a semiparametric analysis on a sample of 100 countries over the period from 1970 to 2014. We test for nonlinear effects on economic growth for two human capital stock indexes assuming both perfect and imperfect substitutability among skilled and unskilled workers. The empirical findings for both indexes suggest that the effect of human capital on countries’ economic growth levels is positive and statistically significant. We provide robust empirical evidence of a nonlinear relationship among human capital and economic growth levels. However, the revealed asymmetric patterns of human capital are more emphatic under the assumption of perfect substitutability among skilled and unskilled workers.

Mergers in durable-goods industries: A re-examination of market power and welfare effects

An important question from the standpoint of antitrust economics is, how do mergers in durable-goods industries differ from those in nondurable-goods industries from the perspective of welfare effects? Previous papers that have considered this issue employ an approach to modeling durable-goods markets that was popularized by Swan in the early 1970s in which new and used “service units” are perfect substitutes in consumption. We employ a modeling approach similar to those employed in later contributions by Anderson and Ginsburgh (1994), Waldman (1996a), and Hendel and Lizzeri (1999) which, more realistically, do not make the perfect substitutability assumption. Our analysis confirms the main result of the earlier literature which is that a competitively supplied stock of used units typically reduces the welfare loss associated with a durable-goods merger. However, we also show that in most cases this reduction is much smaller than found in Carlton and Gertner׳s (1989) classic analysis of the topic. The implication is that the antitrust authorities should be more concerned about mergers in durable-goods industries than the previous literature suggests.

Modern and Traditional Methods for Measuring Money Supply: The Case of Saudi Arabia

This paper compares the “simple-sum” monetary aggregates (M1 and M2) published by the Saudi Arabian Monetary Agency (SAMA) with the new monetary aggregates (D1 and D2)—known as the Divisia monetary indexes. The former aggregates are constructed from a simple accounting identity, whereas the Divisia aggregates are constructed using statistical index number theory and aggregation theory. The findings suggest that both D1 and M1 are identical, given the perfect substitutability of the monetary components within those aggregates. For the broader monetary aggregates where perfect substitutability assumption is not realistic, the two monetary indexes differ substantially. SAMA could benefit by using both monetary indexes simultaneously to better monitor liquidity in the market.

The Generalized Network Problem

Many transport and other service problems come down to simple network choices: what mode and/or route to take, if some of the routes and modes are congested and their use can be priced or not priced by different operators. The operators can have different objective functions: public or private monopoly, private duopoly, etc.. This standard problem has been studied in many variants, mostly using the assumption of perfect substitutability between alternatives, so that in the deterministic Wardrop equilibrium, all routes that are used have the same generalized cost. This paper examines in more detail the role of the perfect substitutability assumption. Users of a network consume transport services, which are differentiated in two ways. There are objective differences in quality (length of route, congestion level) perceived by all users and there are individual idiosyncratic preferences for transport services. The resulting stochastic equilibrium is analysed on a simple parallel network for four types of ownership regimes: private ownership, coordinated public ownership, mixed public-private and public Stackelberg leadership. We find that, firstly, when total demand is fixed and there is congestion, then by controlling one route a government can achieve the First Best allocation, although the second route is privately operated or unpriced. This result holds whatever the level of substitutability and whatever the levels of congestion. Secondly, whenever imperfect substitutability is present, private supply of one of the two routes becomes relatively less efficient because the private supplier has an additional source of market power to exploit. If the better of the two routes is privately supplied it is always insufficiently used. However, if only one route can be privately operated, then this should always be the intrinsically better route.

Troubling tradeoffs in the Human Development Index

The 20th Human Development Report introduced a new version of its famous Human Development Index (HDI), which aggregates country-level attainments in life expectancy, schooling and income. The main change was to relax the past assumption of perfect substitutability between its components. Most users will not, however, realize that the new HDI has also greatly reduced its implicit weight on longevity in poor countries, relative to rich ones. By contrast, the new HDI's valuations of extra schooling are now very high—many times the economic returns. An alternative index is proposed that embodies less troubling tradeoffs while still allowing imperfect substitution.

IT and Beyond: The Contribution of Heterogeneous Capital to Productivity

This paper explores the relationship between capital composition and productivity using a unique and highly detailed data set on firm-level investment in the U.S. We develop a succinct methodology for modeling the separate effects of a large number of capital types in a production function framework. We then use this methodology, combined with recently developed techniques for accounting for unobserved productivity, to identify these effects and back out the implied marginal products of each capital type. The results indicate that information and communications technology (ICT) capital--specifically, computers, software, and communications equipment--are positively and statistically significantly associated with output, even after conditioning on total capital, labor, and various proxies for unobserved productivity. We compare the implied marginal products for different capital types to official data on rental prices and find that the marginal products of the ICT capital types are substantially above their measured rental prices. Lastly, we provide evidence of complementarities and substitutabilities, both among capital types--a rejection of the common assumption of perfect substitutability--and between certain capital types and labor.

The advantage of avoiding the Armington assumption in multi-region models

Most computable general equilibrium models that describe interactions between multiple regions employ the so-called Armington assumption that goods that are produced in different regions are imperfect substitutes for each other. The paper describes an alternative algorithm based on the assumption of perfect substitutability that accommodates the observation that each region produces all traded goods. For models with many regions and less-that-perfectly mobile factors, the alternative algorithm greatly reduces convergence time. The algorithm is illustrated by comparing two static multi-region models of the 50 U.S. states and the District of Columbia, with and without the Armington assumption. The model without the Armington assumption is then extended to a dynamic 51-region model with agents that have perfect foresight over 6 periods.

International Investors, the U.S. Current Account, and the Dollar

International Investors, the U.S. Current Account, and the Dollar Olivier Blanchard, Francesco Giavazzi, and Filipa Sa Two main forces underlie the large U.S. current account deficits of the past decade. The first is an increase in U.S. demand for foreign goods, partly due to relatively faster U.S. growth and partly to shifts in demand away from U.S. goods toward foreign goods. The second is an increase in foreign demand for U.S. assets, starting with high foreign private demand for U.S. equities in the second half of the 1990s, and later shifting to foreign private and then central bank demand for U.S. bonds in the 2000s. Both forces have contributed to steadily increasing current account deficits since the mid-1990s, accompanied by a real dollar appreciation until late 2001 and a real depreciation since. The depreciation accelerated in late 2004, raising the issues of whether and how much more is to come and, if so, against which currencies: the euro, the yen, or the Chinese renminbi. We address these issues by developing a simple model of exchange rate and current account determination, which we then use to interpret the recent behavior of the U.S. current account and the dollar and explore what might happen in alternative future scenarios. The model's central assumption is that there is imperfect substitutability not only between [End Page 1] U.S. and foreign goods, but also between U.S. and foreign assets. This allows us to discuss the effects not only of shifts in the relative demand for goods, but also of shifts in the relative demand for assets. We show that increases in U.S. demand for foreign goods lead to an initial real dollar depreciation, followed by further, more gradual depreciation over time. Increases in foreign demand for U.S. assets lead instead to an initial appreciation, followed by depreciation over time, to a level lower than before the shift. The model provides a natural interpretation of the recent behavior of the U.S. current account and the dollar exchange rate. The initial net effect of the shifts in U.S. demand for foreign goods and in foreign demand for U.S. assets was a dollar appreciation. Both shifts, however, imply an eventual depreciation. The United States appears to have entered this depreciation phase. How much depreciation is to come, and at what rate, depends on how far the process has come and on future shifts in the demand for goods and the demand for assets. This raises two main issues. First, can one expect the deficit to largely reverse itself without changes in the exchange rate? If it does, the needed depreciation will obviously be smaller. Second, can one expect foreign demand for U.S. assets to continue to increase? If it does, the depreciation will be delayed, although it will still have to come eventually. Although there is substantial uncertainty about the answers, we conclude that neither scenario is likely. This leads us to anticipate, in the absence of surprises, more dollar depreciation to come at a slow but steady rate. Surprises will, however, take place; only their sign is unknown. We again use the model as a guide to discuss a number of alternative scenarios, from the abandonment of the renminbi's peg against the dollar, to changes in the composition of reserves held by Asian central banks, to changes in U.S. interest rates. This leads us to the last part of the paper, where we ask how much of the dollar's future depreciation is likely to take place against the euro, and how much against Asian currencies. We extend our model to allow for four "countries": the United States, the euro area, Japan, and China. We conclude that, again absent surprises, the path of adjustment is likely to be associated primarily with an appreciation of the Asian currencies, but also with a further appreciation of the euro against the dollar. [End Page 2] A Model of the Exchange Rate and the Current Account Much of economists' intuition about joint movements in the exchange rate and the current account is based on the assumption of perfect substitutability between domestic...

IT and Beyond: The Contribution of Heterogenous Capital to Productivity

This paper explores the relationship between capital composition and productivity using a unique and remarkably detailed data set on firm-level investment in the U.S. Using cross-sectional and longitudinal regressions, I find that several capital types, including computers, communications equipment, and software, are associated with current and subsequent years' productivity. The implied marginal products are derived and compared to official data on rental prices; substantial differences exist for a number of key capital types. I also provide evidence of complementaries and substitutabilities among capital goods - a rejection of the common assumption of perfect substitutability.

Global warming: discounting is not the issue, but substitutability is

The cost–benefit study of Nordhaus (1994) is representative for the neoclassical approach towards global warming. Nordhaus found that no substantial emission cuts are warranted. Most of his critics have concentrated on the issue of discounting and demanded that a lower discount rate should be applied. These criticisms first miss the point and second lead to ethically dubious, inconsistent conclusions and inefficient policy choices. They miss the point because the real problem of Nordhaus’s methodology is his implicit underlying assumption of perfect substitutability between natural and other forms of capital. Given the validity of this assumption, lowering the rate of discount is inconsistent with current savings behaviour, is ethically dubious because future generations will be much richer than the current one anyway, and is inefficient because scarce financial resources are channelled into emissions abatement that exhibits rates of return far inferior to alternative public investments. Any call for aggressive emission abatement must therefore directly attack the perfect substitutability assumption of neoclassical economics. The real disagreement is about whether consumption growth can compensate for environmental degradation caused by global warming. Discounting is not the issue, but substitutability is.

Balance-of-payments crises and monetary policy reactions in a model with imperfect substitutability between domestic and foreign bonds

We show that if domestic and foreign bonds are imperfect substitutes for each other and the exchange rate is fixed, then, unlike under the perfect substitutability assumption, uncertainty about monetary policy reactions affects the timing of balance-of-payments crises.

Currency substitution and economic monetary aggregates: The U.S. Case

Existing analyses of currency substitution rely on the assumption that domestic monetary assets are perfect substitutes for each other. The present paper examines empirically the currency substitution hypothesis using Divisia monetary aggregates which relax the perfect substitutability assumption used in earlier work. The empirical results support the hypothesis of currency substitution for the United States.

A Test of Perfect Substitutability in the Foreign Exchange Market

I. Motivations for the Test The question of whether or not domestic bonds are perfect substitutes for foreign bonds in investors' portfolios, implying that the expected rates of returns must be equalized across currencies, is an important one for two reasons. The question is crucial, first, for choosing among various models of exchange rate determination and, second, for evaluating tests of efficiency in the forward exchange market. To illuminate the first motivation, a brief discussion of models of exchange rate determination is necessary. All asset-market models share the assumption that there are no significant transactions costs, capital controls, or other impediments to the international flow of capital. Thus actual portfolios adjust instantaneously to equal desired portfolios. This implies, for example, covered interest parity: the domestic interest rate should differ from the foreign interest rate by an amount exactly equal to the forward discount rate. Perfect substitutability between domestic and foreign bonds is the stronger assumption that market participants are indifferent as to the currency composition of their portfolio. It implies uncovered interest parity: the domestic interest rate must differ from the foreign interest rate by an amount exactly equal to the expected rate of depreciation. The perfect substitutability assumption is far from standard. In fact, exchange rate models within the view can be classified into those that belong to the monetary defined by the assumption of perfect substitutability, and those that belong to the defined by the assumption of imperfect substitutability. In the portfolio-balance approach, investors hold well-defined proportions of their wealth in the form of each country's assets, with the proportions depending on the expected rates of return, as in equation (1):