Substitution occurs when firms replace one input for...

Substitution occurs when firms replace one input for another, as when a farmer uses tractors rather than labor when wages rise. Consider the following changes in a firm's behavior. Which represent substitution of one factor for another with an unchanged technology, and which represent technological change? Illustrate each with a graphical production function. a. When the price of oil increases, a firm replaces an oil-fired plant with a gas-fired plant. b. A bookseller reduces its sales staff by 60 percent after it sets up an Internet outlet. c. Over the period $1970-2000,$ a typesetting firm decreases its employment of typesetters by 200 workers and increases its employment of computer operators by 100 workers. d. After a successful unionization drive for clerical workers, a college buys personal computers for its faculty and reduces its secretarial workforce.

Substitution occurs when firms replace one input for another, as when a farmer uses tractors rather than labor when wages rise. Consider the following changes in a firm's behavior. Which represent substitution of one factor for another with an unchanged technology, and which represent technological change? Illustrate each with a graphical production function.
a. When the price of oil increases, a firm replaces an oil-fired plant with a gas-fired plant.
b. A bookseller reduces its sales staff by 60 percent after it sets up an Internet outlet.
c. Over the period $1970-2000,$ a typesetting firm decreases its employment of typesetters by 200 workers and increases its employment of computer operators by 100 workers.
d. After a successful unionization drive for clerical workers, a college buys personal computers for its faculty and reduces its secretarial workforce.

Key Concepts

Input Substitution

This concept refers to the process by which a firm changes its mix of inputs in response to changes in relative input prices while keeping the underlying technology constant. Instead of altering the production process, the firm simply substitutes a relatively cheaper factor for a more expensive one to maintain cost efficiency. This behavior is depicted as movement along a given isoquant in a production function graph.

Technological Change

Technological change involves an alteration in the production process that shifts the production function itself. It represents improvements in technology or the adoption of entirely new methods that change the relationship between inputs and outputs. In a graphical representation, technological change is shown as a shift of the isoquant curve, indicating that for any given level of input, the output level has increased (or for a given output, fewer inputs are needed).

Graphical Representation of Production Functions

A production function graphically displays the relationship between input usage and output levels. It typically involves isoquants representing combinations of inputs that yield the same output. Changes along a given isoquant illustrate input substitution, while a shift of the isoquant depicts technological change. This tool helps in visualizing how firms adjust input mixes in response to economic incentives or technological advancements.

Transcript

00:01 So this problem covers the concept in labor, technology substitution.

00:06 So the problem starts by defining what substitution is.

00:10 Substitution occurs when firms replaces an input for another, just like when a farmer replaces its labor with a tractor.

00:20 So our task here is actually to determine for each of the following scenarios whether there is a change in technology happening.

00:30 In substitution for some kind of input or whether there's an unchange in technology.

00:35 So let's define some symbols we're going to use in the beginning.

00:39 I'll use ut to define an unchanged in technology and i'm going to use a t to define a change in technology.

00:55 So let's begin.

00:57 In part a, the scenario says when the price of oil increase, a firm replaces oil fire plant with gas fire plant.

01:06 Well, that seems like a sensible thing to do because at the time, oil may be pricier than gas.

01:11 So we've got to find another alternative that are cheaper than oil.

01:15 So we're replacing the oil fire plant with gas fire plant.

01:19 So there is a change in technology happening here, also known as a substitution.

01:24 So, and the reason behind this is because there's a change in input methods.

01:31 So, for part b, the scenario says a bookseller reduces the sales staff by 60 % after it sets up an internet outlet...

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