Compatibility of Rails 4 engine with Rails 3 or higher version

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I need to develop a rails app. I am confused on which version should I use for develop 4.2 or 3.2. If I develop on Rails 4.2 will it be compatible with Rails 3 or higher version because we are developing the app as a product.

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I don't understand well your issue. Are you developing from scratch? Then you should use the last stable version (4.2) because you will have support for a longer time. Anything that you code and test will work.

Version problems come when you already have some code and want to update your Rails version while keeping old code, example: You have an old Rails 3 app and for some reason you want to migrate it to Rails 4.

Even then, if you have different existing rails apps in your server, you can use RVM to have them all living at the same time.

It seems there are some concepts missing here: The main problem you have is with your Gemfile and probably some of the new syntax introduced in Rails 4. You just shouldn't be moving code between Rails app which have different versions, that's all.