Elasticity of Substitution between Capital and Labor and its Applications to Growth and Development

51 Pages Posted: 8 Mar 2005

See all articles by Samuel D. Pessoa

Samuel D. Pessoa

Graduate School of Economics at Fundacao Getulio Vargas (EPGE/FGV); University of Pennsylvania

Silvia Matos-Pessoa

University of Pennsylvania - Department of Economics

Rafael Rob

University of Pennsylvania - Department of Economics

Date Written: March 4, 2005

Abstract

This paper estimates the elasticity of substitution of an aggregate production function. The estimating equation is derived from the steady state of a neoclassical growth model. The data comes from the PWT in which different countries face different relative prices of the investment good and exhibit different investment-output ratios. Then, taking advantage of this variation we estimate the long-run elasticity of substitution. Using various estimation techniques, we find that the elasticity of substitution is 0.7, which is lower than the elasticity, 1, that is traditionally used in macro-development exercises. We show that this lower elasticity reinforces the power of the neoclassical model to explain income differences across countries as coming from differential distortions.

Keywords: Demand for Investment, Dynamic Panel Data, Elasticity of Substitution

JEL Classification: D24, D33, E25, O11, O47, O49

Suggested Citation

Pessoa, Samuel D. and Matos-Pessoa, Silvia and Rob, Rafael, Elasticity of Substitution between Capital and Labor and its Applications to Growth and Development (March 4, 2005). Available at SSRN: https://ssrn.com/abstract=680524 or http://dx.doi.org/10.2139/ssrn.680524

Samuel D. Pessoa

Graduate School of Economics at Fundacao Getulio Vargas (EPGE/FGV) ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil
+55 21 559 5833 (Phone)
+55 21 552 4898 (Fax)

University of Pennsylvania ( email )

Department of Economics
Philadelphia, PA 19104-6370
United States

Silvia Matos-Pessoa

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

Rafael Rob (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6775 (Phone)
215-573-2057 (Fax)

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