What is Economic Depreciation?

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Definition Economic Depreciation What is
Economic Depreciation? Economic depreciation
refers to a decrease in the value of an item or
an asset over time. Thedecline in value reduces
the price of the asset in the market.
Assetsgenerally get depreciated because of the
wear and tear. Economic depreciation is different
from the depreciation used in accounting. In
accounting, depreciation is the method of
spreading the cost of an asset over time. This is
done to calculate and record the value of an
asset in the balance sheet. Economic depreciation
becomes more visible as time passes or as
external factors change. This leads to a
reduction in the market value of the asset. In
such cases, if the assets are resold, they fetch
alower amount compared to what was paid to
acquire them.

• How is economic depreciation recorded in the
  system of national accounts? Economically,
  depreciation is recorded as the reduction in
  income owing to the loss in value of capital.
  Depreciation is also known as the Consumption of
  Fixed Capital for this reason.
• While moving from gross measurements to net
  measurements, depreciation is reduced from the
  gross value of the variable. For instance, Net
  GDP can be calculated by subtracting
  depreciation from gross GDP.
• There are two significant elements that lead to
  the decline in value of an asset
• First, the value may change because of changes in
  the prices of the asset class itself due to time
  difference. For instance, measuring the value of
  a new asset in the current year and then again
  aftera year.
• Secondly, the value may also change because of
  the ageing of the asset. For instance, comparing
  the price of a new item bought this year to the
  price of a one-year old item.

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• Together, these two factors affect how prices of
  a good change with time. However, in a strict
  sense of the term, depreciation may only account
  for the second factor.
• Why do assets depreciate?
• Assets may depreciate because of the normal
  process of ageing or because of certain external
  factors. These include
• Normal Wear and Tear Goods that last a long term
  are bound to get affected because of constant
  usage. For instance, the machine equipment in a
  firm might function smoothly for the initial
  years. However, it starts to malfunction and
  becomes slower at later stages. This is
  depreciation caused by wear and tear of the
  machine and is reflected in its market value.
  Therefore, if the company were to resell the
  machine after using it for a few years, then the
  resale value would be lower as the machine is not
  in the same condition, physically, as it was
  before.
• Obsolescence Parts of machinery and equipment
  might become obsolete with time. Similarly, old
  machines might get replaced with equipment that
  has newer technology in it which makes it more
  efficient. Therefore, the old or obsolete
  equipment would be more susceptible to
  depreciation as repairs may not be possible on
  them.
• Normal accidental Damage This refers to the
  accidents encountered in the workplace that can
  cause an asset to depreciate. These accidents are
  the kind of mishaps that are commonly
  encountered in the production process. This
  ultimately leads to these assets being scrapped
  prematurely. Transport equipment might be more
  vulnerable to these kinds of damages.
• Time to expiry Items that have an expiry date
  associated with them or those that are
  perishable are susceptible to loss in value over
  time. As the expiration date comes closer, the
  value of the item decreases. Similarly,
  intangible assets like intellectual property
  rights, patents, etc., also have expiry dates
  attached to them. Therefore, as these rights
  expire, the item or commodity against which the
  right was granted loses its market value.

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• How is economic depreciation calculated?
• There are two methods of measuring depreciation.
  These are
• Through the value of goods produced with the
  asset The depreciation of machinery or
  equipment can be measured by the value of the
  output it produces. For instance, if a machine
  can manufacture 40 units of a good in a day, then
  it is more valuable than if it were to make 20
  units in a day. If the good is priced at US5,
  then the initial value of goods produced by the
  machine is US200, but after depreciation, the
  value becomes US100. Therefore, the
  depreciation, in this case amounts to US100.
• Through the resale value Depreciation can also
  be calculated through the decline in the resale
  value. The difference between the initial price
  of the asset and the resale value can be termed
  as depreciation.
• How does depreciation affect the capital stock in
  an economy?
• In macroeconomics, economic depreciation is
  subtracted from the current capital stockto
• calculate the future capital stock. Depreciation
  can be subtracted as a proportion of the existing
  stock or as a constant value from the existing
  stock.
• When depreciation is reduced as a proportion of
  capital stock, then the capital stock in the next
  period is calculated as follows

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Where Kt1 refers to the capital stock in the
next period, Kt refers to the capital stock in
the current period, d refers to depreciation,
and, It refers to the level of investment in the
economy. When depreciation is taken as a constant
value that is not proportionate to the existing
current stock, then the next period capital
stock is calculated as follows
The meaning of the variables remains unchanged.