Elasticity oj Substitution Between Factors
In the theory of demand. we explained the Concept of elasticity of substitution between goods in the scheme of consumption of a con. MIller. That is, we explained to what extent one good could be substituted by a consumer for another good. In the theory of production, on the other hand. we arc concerned with the factors of production in read of the commodities for consumption. Here we discuss to what extent a factor of production, sa) labour, can be substituted for another factor. say capital. That is, we arc concerned with what may he called elasticity of technical suhst union.
Just as the marginal rate of substitution of Commodity X for commodity Y falls as X is substituted for Y along an indifference curve. similarly the marginal rate of technical substitution (MRTS) of factor X for factor Y declines as factor X is substituted for factor Y along an i Squanto or equal product curve. “The relative change in the factor- proportions (or input ratill~) :IS a cookhouse (If relative in the murmuring rate antiviral title substitution Heimlich radars rate at which the marginal rate of technical substitution falls is a measure of the extent to which the two factor can be substituted for each other. If they arc perfect substitutes, thai is, if either factor can he used equally well to produce the product, the marginal rate of sub. union will not fall. The substitutability or one luctor for another depends on the elasticity or substitution. i.c.. the degree to which it is possible to substitute nile Factor for another. The elasticity can be defined as the percentage change in the rates of the factors used, say X and y, in response to a given percentage change in the marginal rate of technical substitution.This elasticity is unity if a given percentage change in the marginal rate of technical substitution induces and equal change in the factors ratio in the opposite direction; it will be greater than unity if it induces greater percentage change and less than unity if the percentage change induced in the factors ratio is less than the percentage change in the MRTS. Thus,
A high elasticity of substitution means that the factors can he substituted freely for one another, while in the case of low elasticity they can be used only in definite proportions. We can refer to the shape of lsoquants or equal product curves to determine the magnitude of elasticity
of substitution he tween factors. The measure of elasticity depends on the curvature of the isoquauts. The greater the convexity of ixoquant the less will be substitution elasticity, and vice versa. In case the two factors inc perfect substitutes of each other and the isoquauts between them arc straight lines, substitution elasticity between them is infinite. On the other hand, when the two factors are perfect complements and their isoquants are right angled, the substitution elasticity between them is zero. Besides, since there is inverse relationship between the marginal rate of substitution and factor-ratio (i.e., as the factor-ratio increases. the marginal rate of technical substitution falls). elasticity of substitution between factors is always negative. The concept of elasticity of substitution also occupies an important place in the theory of distribution. It affects the distributive shares of the factors of production. For example, the relative shares of labour and capital will largely depend on the elasticity of substitution between them. If capital can be freely substituted for labour. the share of labour relative to the share of capital is bound to decline.