Aggregate elasticity of substitution and economic growth: A synthesis

This paper examines the relation between aggregate elasticity of substitution (AES) and capital accumulation (the AES-K relation) in a two-level, two-sector Solow growth model. There are two intermediate goods produced by capital and labor, while the final good is produced by combining the two intermediate goods. When capital (labor) is only used in producing one of the intermediate goods, then a negative (positive) AES-K relation is the likely outcome. Without specific factors in production, then we have to differentiate the concepts of “global” versus “local” AES-K relation. While the local AES-K relation is possibly monotone, the global AES-K relation is always non-monotone. When the intermediate goods are gross substitutes (complements) in the final-good production, the global AES-K relation is hump- (U-) shaped.