The Elasticity of Substitution and Characteristics of New Investments

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.