Capital‐Labour Substitution in Macroeconomics: A Survey of Mechanisms, Dynamics and Policy Insights

ABSTRACT Macroeconomic conclusions often hinge on a single, hard‐to‐pin‐down parameter: the elasticity of substitution between capital and labour, σ . This survey synthesises theory and evidence on how results change once we move beyond the Cobb–Douglas benchmark (). We show how shapes factor income shares and productivity responses to capital deepening and technological change; how it alters transition dynamics; how it steers the direction of technological change; and how, by scaling factor‐demand elasticities, it amplifies taxation and misallocation effects. In labour‐market and matching frameworks, conditions how productivity and capital‐deepening shocks translate into wages and unemployment. Finally, affects equilibrium (in)determinacy and the scope for sunspots, bifurcations, and complex dynamics, depending on adjustment margins (such as variable capital utilization), externalities, financial constraints and policy feedback rules. By integrating classical insights with recent developments, this survey offers a coherent guide to macroeconomic mechanisms and public policy design.