The elasticity of substitution: evidence from a UK firm-level data set

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 19 March 2008

Working Paper No. 348
By Sebastian Barnes, Simon Price and María Sebastiá Barriel

Using a panel of UK firms spanning three decades, we provide estimates of the long-run elasticity of substitution between capital and other factors of production, the (negative of the) elasticity of capital and investment with respect to the user cost. The parameter is estimated using ‘time averages’ (with data differenced over long periods) and pooled mean group panel methods. The robust result is that the elasticity is in the region of 0.4. This is consistent with previous results obtained using aggregate UK data, and is also in line with some recent results using US firm-level data. Estimated returns to scale exceed unity. When constant returns are imposed, the estimated elasticity of substitution is not substantially changed.

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