2.4. Depreciation

In the process of production, all machines and equipment used to produce other goods, are subject to some wear and tear. In economic parlance, this loss of capital which every economy has to suffer is called as Depreciation.

A part of capital goods produced in the economy must be devoted to replace this wear and tear. Otherwise, the productive capacity of a nation would be depleted. This replacement of the capital used is Capital Consumption Allowance.

In this scenario, the investment expenditure of the firms is made up of two parts. One part is to buy new capital goods and machinery for production. It is called Net Investment because the production capacity of the firms can be expanded.

Another part is spent on replacing the used-up capital goods or the maintenance of existing capital goods. The expenses incurred for this are called Depreciation Expenditure.

The total investment by firms comprising these two amounts is called Gross Investment. Gross Investment = Net Investment + Depreciation

Or, Net Investment = Gross Investment – Depreciation. The Net investment increases the production capacity and output of a nation if it is positive. This can easily be verified at the level of a single plant: the number of new machines installed in any given year must be greater than the machines that have been used up during that year.

The governments decide and announce the rates by which assets depreciate and a list is published, which is used by the different sections of the economy to determine the real levels of depreciations in different assets.