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User cost refers to the expenses borne by the owner or renter of a capital asset resulting from the use of the asset for a given period of time. The user cost of capital also is sometimes referred to as the “implicit rental price” or the”price of capital services.” A capital asset in theory can be any asset that is long-lived, which typically means it has a service life of more than one year. Durable goods such as machinery, factories, automobiles, computers, and even houses are examples of “tangible” capital assets. There are also “intangible” capital assets such as a business’s technological knowledge base built up by past research and development (R&D) activity or the value of its brand(s) built up by past marketing efforts.
Along with labor input, the service flows from capital assets are used by businesses to generate revenue. For many applications in economic research, such as measuring “multifactor” productivity or evaluating the potential effect on investment of changes in tax policy, one needs to measure the prices of capital and labor services. For labor, measuring this price is easy: It is simply the wage. For capital, though, measuring the price of a unit of service, that is, the user cost, can be much more complicated. If the firm leases a car for a year, for example, then, as with “renting” labor, the user cost is simply the rental price. This rent compensates the car’s owner for “wear and tear” (depreciation) inflicted on the car over the year, taxes on the rental income, the decline in its market (e.g., “blue book”) value over the year, and the foregone interest the owner could have earned if she had instead sold the car and invested those funds. Most capital assets used by a firm, however, are owned by the firm. Nonetheless, one can think of the firm as renting these assets to itself at an “implicit” rental price, equal to what the firm would get if it rented these assets out to other firms. In fact, government statistical agencies and others attempting to measure the user costs of specific capital assets often measure them by the prices observed in rental markets.
Most types of capital, however, do not have active rental markets. In these cases, the user cost is often measured by appealing to the neoclassical model and the seminal work of Robert Hall and Dale Jorgenson (1967). Hall and Jorgenson derived the formula for the user cost based on the neoclassical model’s proposition that the price of a capital asset should be equal to the present value of the rental income stream generated by the asset net of taxes and depreciation. From this equation, one can solve for the rental income per period, that is, the user cost, as a function of the price of the capital asset, the expected change in its price over the period, the interest rate, the depreciation rate, and taxes. Because these values are either known or can be estimated reasonably well, the user cost can be calculated using this formula.
It should be noted that this neoclassical concept of user cost is distinct from Keynes’s concept of user cost, which, roughly speaking, is the total cost to a firm of using capital in production (whereas the neoclassical user cost can be thought of as the price of a unit of services from that capital). The Keynesian user cost captures the value of capital that is “used up” or “consumed” in the production process. In Keynes’s production framework, the sum of labor (“factor”) cost and user cost equals the total (“prime”) cost of production.
Bibliography:
- Hall, Robert E., and Dale W. Jorgenson. 1967. Tax Policy and Investment Behavior. American Economic Review 57 (2): 391–414.
- Keynes, John Maynard. 1936. General Theory of Employment, Interest, and Money. London: Macmillan.
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