The Elasticity of Substitution and Characteristics of New Investments

Author(s)
Carl-Gustav Melén

ABSTRACT

Changes in the interest rate and the capital cost will influence important characteristics of investments, such as the expected life time, the factor intensity and the factor productivity of new capital goods. When Harrod-neutral technical progress is endogenous and variable, an increased interest rate will lower the lifetime as well as the factor intensity of the capital good in the Cobb-Douglas case, while there will be a reversed outcome when the substitutability between factor inputs is low. The latter outcome can be interpreted in terms of a reswitching process, that is, one identical factor intensity can arise at two different factor price ratios.

Changes in the interest rate and the capital cost will influence important characteristics of investments, such as the expected life time, the factor intensity and the factor productivity of new capital goods. When Harrod-neutral technical progress is endogenous and variable, an increased interest rate will lower the lifetime as well as the factor intensity of the capital good in the Cobb-Douglas case, while there will be a reversed outcome when the substitutability between factor inputs is low. The latter outcome can be interpreted in terms of a reswitching process, that is, one identical factor intensity can arise at two different factor price ratios.

Cite this paper

C. Melén, "The Elasticity of Substitution and Characteristics of New Investments,"*Modern Economy*, Vol. 3 No. 2, 2012, pp. 150-159. doi: 10.4236/me.2012.32021.

C. Melén, "The Elasticity of Substitution and Characteristics of New Investments,"

References

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[6] J. Duffy and C. Papageorgiou, “A Cross-Country Empirical Investigation of the Aggregate Production Function Specification,” Journal of Economic Growth, Vol. 5, No. 1, 2000, pp. 87-120. doi:10.1023/A:1009830421147

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[19] Z. Han and B. Schefold, “An Empicical Investigation of Paradoxes: Reswitching and Reverse Capital Deepening in Capital Theory,” Cambridge Journal of Economics, Vol. 30, No. 5, 2006, pp. 737-765. doi:10.1093/cje/bei089

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[25] R. Esposti and P. Pierani, “Price-Induced Technical Progress in Italian Agriculture,” Review of Agricultural and Environmental Studies, INRA Department of Economics, Vol. 89, No. 4, 2008, pp. 5-28.

[26] Q. Paris, “Price-Induced Technical Progress in 80 Years of US Agriculture,” Journal of Productivity Analysis, Vol. 30, No. 1, 2008, pp. 29-51. doi:10.1007/s11123-008-0083-9

[27] C.-G. Melén, “A Note on Factor Prices and Technical Progress,” Technology and Investment, Vol. 2, No. 3, 2011, pp. 202-210. doi:10.4236/ti.2011.23021

[1] J. Haltiwanger, J. Lane and J. Speltzer, “Productivity Differences across Employers: The Roles of Employer Size, Age, and Human Capital,” American Economic Review, Vol. 89, No. 2, 1999, pp. 94-98. doi:10.1257/aer.89.2.94

[2] M. Baily, E. Bartelsman and J Halltiwanger, “Labor Productivity: Structural Change and Cyclical Dynamics,” Review of Economics and Statistics, Vol. 83, No. 3, 2001, pp. 420-433. doi:10.1162/00346530152480072

[3] C. Papageorgiou and M. Saam, “Two-Level CES Production Technology in the Solow and Diamond Growth Models,” Discussion Paper, Department of Economics, Louisiana State University, Baton Rouge, Vol. 2005-07, 2005.

[4] R. Klump and O. De La Grandville, “Economic Growth and the Elasticity of Substitution: Two Theorems and Some Suggestions,” American Economic Review, Vol. 90, No. 1, 2000, pp. 282-291. doi:10.1257/aer.90.1.282

[5] K. Miyagiwa and C. Papageorgiou, “Endogenous Aggregate Elasticity of Substitution,” Journal of Economics and Dynamics, Vol. 31, No. 6, 2007, pp. 2899-2919. doi:10.1016/j.jedc.2006.06.009

[6] J. Duffy and C. Papageorgiou, “A Cross-Country Empirical Investigation of the Aggregate Production Function Specification,” Journal of Economic Growth, Vol. 5, No. 1, 2000, pp. 87-120. doi:10.1023/A:1009830421147

[7] C. M. Pereira, “Variable Elasticity of Substitution, Technical Change, and Economic Growth,” Working Paper, Department of Economics, North Carolina State University, Raleigh, 2004.

[8] K. J. Arrow, H. B. Chenery, B. S. Minhas and R. M. Solow, “Capital-Labor Substitution and Economic Efficiency,” Review of Economics and Statistics, Vol. 43, No. 3, 1961, pp. 225-250. doi:10.2307/1927286

[9] N. Kaldor, “Capital Accumulation and Economic Growth,” In: E. A. Lutz and D. C. Hague, The Theory of Capital, St. Martins Press, New York, 1961, pp 177-222.

[10] E. R. Berndt, “Reconciling Alternative Estimates of the Elasticity of Substitution,” Review of Economics and Statistics, Vol. 58, No. 1, 1976, pp. 59-68. doi:10.2307/1936009

[11] S. Gilchrist and J. C. Williams, “Investment, Capacity and Output: A Putty-Clay Approach,” Federal Reserve Board, Washington, 1998.

[12] L. Johansen, “Substitutions versus Fixed Production Coefficients in the Theory of Economic Growth: A Synthesis,” Econometrica, Vol. 27, No. 2, 1959, pp. 157-176. doi:10.2307/1909440

[13] M. Lasky, “A Putty-Clay Model of Business Fixed Investment,” CBO Technical Paper, Washington, 2003.

[14] W. E. G. Salter, “Productivity and Technical Change,” Cambridge University Press, Cambridge, 1960.

[15] R. M. Solow, “Substitution and Fixed Proportion in the Theory of Capital,” Review of Economic Studies, Vol. 29, No. 3, 1962, pp. 207-218. doi:10.2307/2295955

[16] H. D. Kurz, Ed., “Critical Essays on Piero Sraffa’s Legacy in Economics,” Cambridge University Press, Cambridge, 2000.

[17] J. Robinson, “The Production Function and the Theory of Capital,” Collected Economic Essays, Oxford Unversity Press, Oxford, Vol. 2, 1960.

[18] P. A. Samuelson, “Parable and Realism in Capital Theory: The Surrogate Production Function,” Review of Economic Studies Vol. 29, No. 3, 1962, pp. 193-206. doi:10.2307/2295954

[19] Z. Han and B. Schefold, “An Empicical Investigation of Paradoxes: Reswitching and Reverse Capital Deepening in Capital Theory,” Cambridge Journal of Economics, Vol. 30, No. 5, 2006, pp. 737-765. doi:10.1093/cje/bei089

[20] D. Acemoglu, “Equilibrium Bias of Technology,” Econometrica, Vol. 75, No. 5, 2007, pp. 1371-1410. doi:10.1111/j.1468-0262.2007.00797.x

[21] J. R. Hicks, “The Theory of Wages,” St. Martins Press, New York, 1932.

[22] S. Ahmad, “On the Theory of Induced Innovation,” Economic Journal, Vol. 76, 1966, pp. 344-357. doi:10.2307/2229720

[23] Y. Hayami and V. W. Ruttan, “Agricultural Development: An International Perspective,” 2nd Edition, Johns Hopkins University Press, Baltimore, 1985.

[24] C. G. Thirtle, “The Microeconomic Approach to Induced Innovation: A Reformulation of the Hayami and Ruttan Model,” Manchester School of Economic and Social Structure, Vol. 53, No. 3, 1985.

[25] R. Esposti and P. Pierani, “Price-Induced Technical Progress in Italian Agriculture,” Review of Agricultural and Environmental Studies, INRA Department of Economics, Vol. 89, No. 4, 2008, pp. 5-28.

[26] Q. Paris, “Price-Induced Technical Progress in 80 Years of US Agriculture,” Journal of Productivity Analysis, Vol. 30, No. 1, 2008, pp. 29-51. doi:10.1007/s11123-008-0083-9

[27] C.-G. Melén, “A Note on Factor Prices and Technical Progress,” Technology and Investment, Vol. 2, No. 3, 2011, pp. 202-210. doi:10.4236/ti.2011.23021