Thesis notes:

Inflation, factor substitution and growth:

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp280.pdf?
1f87d9a0053c690b40912841d514d931

The paper highlights the negative influence of inflation on the allocative decisions in
the real economy and shows how this relationship can be introduced into a simple
monetary growth model by endogenizing the aggregate elasticity of substitution.

Hicks (1963) regarded as the three different ways in which the substitution between
factors of production can take place: as inter-sectoral substitution of production, as
intra-sectoral substitution of the known methods of production or as substitution by
innovations.

If prices lose their information function because of higher price instability market
integration with domestic and foreign trading partners will shrink and the aggregate
elasticity of substitution will decrease. Supported by recent papers by Ferreira and
Trejos (2002) and Miyagiwa and Trejos (2003).

Duffy and Papageorgiu (2000) find in large cross country study, supplementing nicely
the study by Khan and Senhadji (2000), that elasticities of substitution are significantly
different between developed and non-developed countries. Typically, the latter group
has a σ (elasticity of substitution) well below unity, whereas in the former group σ is
measured to range above unity. This proves in a certain sense the conjecture by Klump
and De La Grandville (2000) that the process of economic development itself, usually
regarded as a steady increase in an economy’s division of labour and market flexibility,
should be positively correlated with the aggregate level of σ.

THE NORMALIZED CES PRODUCTION FUNCTION THEORY AND EMPIRICS.

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1294.pdf?
21ce975f75836e80625ec1e5b9a7edec

Substituting scarce factors of production by relatively more abundant ones is a key

element of economic efficiency and a driving force of economic growth. A measure
of that force is the elasticity of substitution between capital and labor which is the
central parameter in production functions, and in particular CES (Constant Elasticity of
Substitution) ones.

Normalization key to estimate elasticity: Normalization essentially implies representing

the production function in consistent indexed number form.

The link between economic growth and the size of the substitution elasticity has long
been known. As already demonstrated by Solow (1956) in the neoclassical growth
model, assuming an aggregate CES production function with an elasticity of
substitution above unity is the easiest way to generate perpetual growth.
The degree of factor substitution can thus be regarded as a determinant of the steady
state just as important as the savings rate or the growth rate of the labor force. Klump
et al. (2008) (p. 655)