New Estimates of the Elasticity of Substitution Between Land and Capital

We reconcile conflicting evidence on the magnitude of the elasticity of substitution between land and capital, which is a key determinant of the relationship between the price of land and the density of land use. We first use a series of Monte Carlo experiments to compare the performance of classic estimation approaches with a new estimation procedure. We then apply the approaches to various real-world data sets drawn from Berlin, Chicago, and Pittsburgh. Our results indicate that many existing estimates are likely to be biased downward, and the true elasticity is likely to be closer to one than widely believed in the literature. The results suggest that a Cobb-Douglas form is a reasonable approximation to of the production function for housing.

Keywords: Elasticity of substitution, housing production function, land values, Monte Carlo simulation