Countercyclical Elasticity of Substitution

44 Pages Posted: 5 Nov 2014 Last revised: 12 Jan 2017

See all articles by Dongya Koh

Dongya Koh

University of Arkansas - Department of Economics

Raül Santaeulàlia-Llopis


Date Written: January 12, 2017


We empirically show that the short-run elasticity of substitution between capital and labor ($\sigma_t$) is countercyclical. In recessions, capital and labor are more substitutable than in expansions. We explore the effects of the countercyclicality of $\sigma_t$ on aggregate fluctuations in the context of an otherwise standard competitive-markets business cycle model. The countercyclical $\sigma_t$ contributes to resolve four main labor-market puzzles: Dunlop-Tarshis phenomenon, labor-productivity puzzle, hours-productivity puzzle, and labor share puzzle.

Keywords: elasticity of substitution, aggregate fluctuations, labor markets, Dunlop-Tarshis, labor productivity, labor share

JEL Classification: C63, E13, E32

Suggested Citation

Koh, Dongya and Santaeulalia-Llopis, Raul, Countercyclical Elasticity of Substitution (January 12, 2017). Available at SSRN: or

Dongya Koh (Contact Author)

University of Arkansas - Department of Economics ( email )

Fayetteville, AR 72701
United States

HOME PAGE: http://

Raul Santaeulalia-Llopis

MOVE-UAB ( email )

Plaza Cívica, s/n
Bellaterra, Barcelona 08193


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