Under US law, depreciation allowances are based on the original cost of acquiring the asset. No account is taken for the effects of inflation on the price level over time.
a. How does inflation affect the real value of depreciation allowances? Organize your answer around Equation (19.1).
b. When inflation increases, what is the impact on the user cost of capital? Organize your answer around Equation (19.5) .
c. Suggest a policy that could undo the effects of inflation from part b.