Terminology it is helpful to establish conventions about terminology given the various elasticity concepts used in the micro and macro literatures. Elasticity is an economics concept that measures the responsiveness of one variable to changes in another variable. The elasticity of substitution is considered to be quite stable over time and this analysis takes a snapshot of input substitution in the last two decades. When we shut down the extensive margin in our model, however, our measured elasticity is the same as the true elasticity. First, i derive a number of conditions such as the optimal demand schedule when aggregation technology is ces. We distinguish between elasticities based on the margin of response extensive vs. This paper develops a classification scheme of the many different definitions of elasticities of substitution and complementarity in the production case based on duality, gross and net substitution, elasticity type, and four different basic concepts of substitution and complementarity.
We generalize the normalized constant elasticity of substitution ces production function by allowing the elasticity of substitution to vary isoelastically with i the relative factor share, ii. When measuring the elasticity of substitution between two factors when there are other factors in the production function, one must take care of controlling for possible cross effects. Todays featured guest is the elasticity of substitution. Elasticity of factor substitution is zero for leontief function, one for cobb douglas function and constant for linear and ces function.
International finance discussion papers are preliminary materials circulated to stimulate discussion and critical comment. In the extreme case of leontief no substitution technology, where the l. This chapter lays out the theoretical foundation of the measurement of the degree of substitutability among inputs utilized in a production process. One of the limitations of cobbdouglas production function is the unitary elasticity of substitution between labour and capital. Trade elasticity of substitution and equilibrium dynamics. An assessment of ces and cobbdouglas production functions 1 eric miller email. Suppose you drop two items from a secondfloor balcony. Lecture notes on elasticity of substitution ted bergstrom, ucsb economics 210a march 3, 2011 todays featured guest is \the elasticity of substitution. Download lecture notes on elasticity of substitution book pdf free download link or read online here in pdf. The elasticity of substitution between capital and labor is central for several. But we can see no theo retical justification for either of these assumptions12.
Elasticity of substitution between labor and capital. Pdf chapter 4 elasticities of substitution semantic. A key parameter in economics is the elasticity of substitution between capital. Papers can be downloaded free of charge from the following websites. For similar rea sons, engineers measure the stretchability of a material by an elasticity of the. Are micro and macro labor supply elasticities consistent.
Specifically, it arises in a particular type of aggregator function which combines two or more types of consumption goods, or two or more types of production inputs into an aggregate quantity. For example, the elasticity of demand for latte is 2. The elasticity of substitution between time and market. We implement a now standard structural method due to feenstra 1994 to estimate elastic. The microeconomic foundations of aggregate production. Lecture84 elasticity of substitution micro economics iitk. It proceeds from the wellsettled hicksian notion of this measure for two inputs typically labor and capital to the more challenging conceptualization for technologies with more than two inputs most notably, allenuzawa and morishima. In this case, the majority voting equilibrium, if one exists, is. If, on the other hand, it declines rapidly, elasticity of substitution will be low. Elasticity of substitution an overview sciencedirect. As we discussed in the lecture, this quantity measures the extent to which firms can substitute capital for labor as the relative productivity or the relative cost of the two. Journal of the european economic association february 2012 101. Constant elasticity of substitution production function. Lecture notes on elasticity of substitution ted bergstrom, ucsb economics 210a october 26, 2015 todays featured guest is \the elasticity of substitution.
Assume that people who drink coke also drink pepsi. Intermediate microeconomics dirk bergemann, spring 2012 week of 122 128 1 lecture 5. The question that presents itself now is whether it is possible to estimate the elasticity of substitution from the observed data. Elasticity allows us to compare the demands for different goods. Our paper also relates to studies on the response of household consumption to income shocks. The elasticity of substitution between capital and labor is defined as ln ln dkn dmplmpk. In this section, i assume as in krugman 1979 that the increase in product variety made possible through trade induces an increase in the. Estimate of the elasticities of substitution of the ces and translog production functions in tunisia article pdf available in international journal of economics and business research 93. This paper quantifies the elasticity of substitution between bank deposits and treasurys. This video shows how to solve for the elasticity of substitution, which measures how sensitive the kl ratio is to changes in the wr ratio. It is the elasticity of substitution, when defined in a. A model with free mobility of workers and firms and compensating wage. Elasticity of input substitution, technological progress.
Free trade, factor returns, and factor accumulation, journal. Elasticity of substitution in capitalenergy relationships. School of economics elasticity of input substitution. In this part we will examine how changes in factor prices affect the shares of factors and income distribution. Extending the concept of the elasticity of substitution from a twoinput production function into one with three or more inputs invites complications. Elasticity of demand is the ratio of two percentages and so elasticity is a number with no units. Speci cally, we exploit the fact that at the optimum, households equate the marginal return from shopping to their opportunity cost of time. In this article we will discuss about the constant elasticity of substitution production function. However, technological change takes place continuously, and this shifts the production function, leading to changes in the kl ratio and the elasticity of substitution.
However, a standard model of the international business cycle displays multiple locally isolated equilibria if the trade elasticity of substitution is suciently. Pdf isoelastic elasticity of substitution production. Pdf estimate of the elasticities of substitution of the. The base is the x1 axis and the hypotenuse is the tangent line between the other two sides.
In contrast, jaeger 1996, revised 2007, borjas, grogger, and hanson, 2008, 2010, and aydemir and borjas 2007 estimate an effectively in. In a competitive market, it measures the percentage change in the ratio of two inputs used in response to a percentage change in their prices. We consider a consumer with cobbdouglas preferences. Classification of the elasticities of substitution and complementarity. The model developed in this report estimates values for the elasticity of substitution, which is a measure. We have assumed up to now a given production function. As pointed out by nelson 1965, the elasticity of substitution can be interpreted as an index of the rate at which diminishing marginal returns set in as one factor is increased with respect to the other. The elasticity of input substitution and the shares of factors of production. Pdf elasticities of substitution and complementarity researchgate.
How does demand for coke change when the price for pepsi changes. It is part of a larger category called constant elasticity of substitution ces utility functions. That is, the elasticity of substitution computed on the basis of the impact. Changes in the elasticity of substitution between varieties in the spirit of krugman 1979,1980, i now examine the impact of trade on two economies of the kind previously described. Liquidity premium and the substitution between bank. What is the concept of elasticity of factor substitution. A toolkit for changing elasticity of substitution production. Elasticity of substitution in trade 583 our a priori expectation. Trade elasticity of substitution and equilibrium dynamics martin bodenstein note. Elasticity of technical substitution, technical progress and factor shares eco. Substitution elasticities in a ces production framework.
When we make a similar measurement in our model after a decrease in tariffs, we find an armington elasticity that is more than 3 times the true value. Pdf this paper develops a classification scheme of the many different. The vast majority of important economic decisions are of this type. Papers can be downloaded free of charge from the diw berlin website. Elasticity of substitution between capital and labor. Elasticity of substitution between clean and dirty energy inputs zew. Elasticity of substitution is the elasticity of the ratio of two inputs to a production or utility. Elasticities of substitution and complementarity munich personal. The estimation of the elasticity of substitution of a ces production function. For these functions free chosen elasticities of substitution can be attributed to as many discrete factor intensity intervals as is desired. Lecture notes on elasticity of substitution pdf book. If marginal rate of technical substitution declines slowly, elasticity of substitution between the two factors will be high. Estimation of sectoral elasticities of substitution along. When epple and romano 1996 calibrated their model the evidence available at that time pointed to a low elasticity of substitution between education quality and the numeraire good.
Constant elasticity of substitution ces, in economics, is a property of some production functions and utility functions. Recall from 103 that elasticity is the ratio of two variables percentage change. As factor prices change, the firm will substitute a cheaper input for a more expensive one. This site is like a library, you could find million book here by using search box in the header. Pdf the estimation of the elasticity of substitution of. Lecture notes on elasticity of substitution ucsb department of. Elasticity of substitution factor ratios consider the right triangle formed by drawing a vertical line from the intersection of the two tangent lines and the x1 axis. Elasticity of a function of a single variable before we meet this guest, let us spend a bit of time with a slightly simpler notion, the elasticity of a a function of a single variable.
This implies varians monotonicity, and is an assumption that has more content than think of radioactive material as an input to electricity productioncan it be disposed of freely. A measure free from this objection fortunately now lies ready to hand. The first item is a tennis ball, and the second item is a brick. Elasticity of substitution is the elasticity of the ratio of two inputs to a production or utility function with respect to the ratio of their marginal products or utilities. Since the introduction of the ces production function in 1956, a multitude of extensive studies on the elasticities of substitution between production inputs have been published. Innoationv and crosscountry di erences in technological development are only taken into account to correctly identify the elasticity of substitution.
Werte siehe tabelle 1 estimates of the elasticity of substitution in chirinko 2008. How does demand for pepsi change when the price for coke changes. Read online lecture notes on elasticity of substitution book pdf free download link book now. If the elasticity of substitution is large, then it.
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