Lecture84 elasticity of substitution micro economics iitk. Assume that people who drink coke also drink pepsi. Elasticity of substitution in capitalenergy relationships. Elasticity of substitution in trade 583 our a priori expectation. It is part of a larger category called constant elasticity of substitution ces utility functions. School of economics elasticity of input substitution. Read online lecture notes on elasticity of substitution book pdf free download link book now. 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. 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. A measure free from this objection fortunately now lies ready to hand.
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. Free trade, factor returns, and factor accumulation, journal. Pdf isoelastic elasticity of substitution production. Elasticity of technical substitution, technical progress and factor shares eco.
Lecture notes on elasticity of substitution ted bergstrom, ucsb economics 210a march 3, 2011 todays featured guest is \the elasticity of substitution. But we can see no theo retical justification for either of these assumptions12. Intermediate microeconomics dirk bergemann, spring 2012 week of 122 128 1 lecture 5. For these functions free chosen elasticities of substitution can be attributed to as many discrete factor intensity intervals as is desired.
In this case, the majority voting equilibrium, if one exists, is. One of the limitations of cobbdouglas production function is the unitary elasticity of substitution between labour and capital. 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. 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. 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. Pdf estimate of the elasticities of substitution of the. Lecture notes on elasticity of substitution ucsb department of. Elasticities of substitution and complementarity munich personal. Constant elasticity of substitution ces, in economics, is a property of some production functions and utility functions. Extending the concept of the elasticity of substitution from a twoinput production function into one with three or more inputs invites complications. Elasticity of factor substitution is zero for leontief function, one for cobb douglas function and constant for linear and ces function.
In this article we will discuss about the constant elasticity of substitution production function. When we shut down the extensive margin in our model, however, our measured elasticity is the same as the true elasticity. Pdf this paper develops a classification scheme of the many different. Download lecture notes on elasticity of substitution book pdf free download link or read online here in pdf. Innoationv and crosscountry di erences in technological development are only taken into account to correctly identify the elasticity of substitution. 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 substitution between clean and dirty energy inputs zew. Estimation of sectoral elasticities of substitution along.
The elasticity of substitution between capital and labor is central for several. We implement a now standard structural method due to feenstra 1994 to estimate elastic. For example, the elasticity of demand for latte is 2. This paper quantifies the elasticity of substitution between bank deposits and treasurys. 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 production function. It is the elasticity of substitution, when defined in a. Recall from 103 that elasticity is the ratio of two variables percentage change. However, technological change takes place continuously, and this shifts the production function, leading to changes in the kl ratio and the elasticity of substitution. We estimate that households opportunity cost of time declined by 1426 percent over 20082010. Werte siehe tabelle 1 estimates of the elasticity of substitution in chirinko 2008. What is the concept of elasticity of factor substitution. Pdf elasticities of substitution and complementarity researchgate. Elasticity allows us to compare the demands for different goods.
Elasticity of substitution an overview sciencedirect. Suppose you drop two items from a secondfloor balcony. Pdf chapter 4 elasticities of substitution semantic. References to international finance discussion papers other than an acknowledgment that the writer has had access to unpublished. Lecture notes on elasticity of substitution ted bergstrom, ucsb economics 210a october 26, 2015 todays featured guest is \the elasticity of substitution. We consider a consumer with cobbdouglas preferences. We have assumed up to now a given production function. Trade elasticity of substitution and equilibrium dynamics martin bodenstein note.
The elasticity of input substitution and the shares of factors of production. 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. A note on ces functions drago bergholt, bi norwegian business school 2011 functions featuring constant elasticity of substitution ces are widely used in applied economics and. If the elasticity of substitution is large, then it. Cobbdouglas preferences are easy to use and therefore commonly used. The question that presents itself now is whether it is possible to estimate the elasticity of substitution from the observed data. Elasticity of demand is the ratio of two percentages and so elasticity is a number with no units.
The first item is a tennis ball, and the second item is a brick. In this part we will examine how changes in factor prices affect the shares of factors and income distribution. Pdf the estimation of the elasticity of substitution of. How does demand for coke change when the price for pepsi changes.
Elasticity of input substitution, technological progress. The base is the x1 axis and the hypotenuse is the tangent line between the other two sides. In the extreme case of leontief no substitution technology, where the l. In contrast, jaeger 1996, revised 2007, borjas, grogger, and hanson, 2008, 2010, and aydemir and borjas 2007 estimate an effectively in. Liquidity premium and the substitution between bank. Lecture notes on elasticity of substitution pdf book. The elasticity of substitution between capital and labor is defined as ln ln dkn dmplmpk. All books are in clear copy here, and all files are secure so dont worry about it. Speci cally, we exploit the fact that at the optimum, households equate the marginal return from shopping to their opportunity cost of time. The microeconomic foundations of aggregate production.
If, on the other hand, it declines rapidly, elasticity of substitution will be low. 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. Elasticity of substitution between capital and labor. International finance discussion papers are preliminary materials circulated to stimulate discussion and critical comment. The model developed in this report estimates values for the elasticity of substitution, which is a measure. Elasticity of substitution is the elasticity of the ratio of two inputs to a production or utility. 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. Substitution elasticities in a ces production framework. Trade elasticity of substitution and equilibrium dynamics. Journal of the european economic association february 2012 101. We distinguish between elasticities based on the margin of response extensive vs. Todays featured guest is the elasticity of substitution. 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.
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. 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. 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. 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. 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.
However, a standard model of the international business cycle displays multiple locally isolated equilibria if the trade elasticity of substitution is suciently. Papers can be downloaded free of charge from the diw berlin website. Our paper also relates to studies on the response of household consumption to income shocks. Terminology it is helpful to establish conventions about terminology given the various elasticity concepts used in the micro and macro literatures.
The estimation of the elasticity of substitution of a ces production function. A toolkit for changing elasticity of substitution production. As factor prices change, the firm will substitute a cheaper input for a more expensive one. 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. That is, the elasticity of substitution computed on the basis of the impact. An assessment of ces and cobbdouglas production functions 1 eric miller email.
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. 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. Elasticity is an economics concept that measures the responsiveness of one variable to changes in another variable. In this section, i assume as in krugman 1979 that the increase in product variety made possible through trade induces an increase in the. First, i derive a number of conditions such as the optimal demand schedule when aggregation technology is ces. A key parameter in economics is the elasticity of substitution between capital. Elasticity of substitution between labor and capital. A model with free mobility of workers and firms and compensating wage. This chapter lays out the theoretical foundation of the measurement of the degree of substitutability among inputs utilized in a production process. The vast majority of important economic decisions are of this type. This site is like a library, you could find million book here by using search box in the header. Classification of the elasticities of substitution and complementarity. If marginal rate of technical substitution declines slowly, elasticity of substitution between the two factors will be high. The elasticity of substitution between time and market.1539 75 197 1302 545 548 946 111 599 273 496 1609 205 730 668 628 1389 44 392 1519 1305 574 1340 929 233 560 1635 959 111 392 1615 1261 1360 706 706 768 74 268 1070 299 831 93 1190