Question

Why is the elasticity of substitution between labor and capital an important concept in Macroeconomics and production

Answer 1

The elasticity of substitution between labor and capital (σ) is one of the key characteristics of supply side of the economy. When the elasticity of substitution equals unity then the CES production function nests the Cobb-Douglas form which persists almost as a paradigm in modern macroeconomic modelling.

A small drop in the price of lawnmowers probably is not going to cause Josh to replace two workers with two lawnmowers. The elasticity of substitution between workers and lawnmowers within his business is likely to be low.When the elasticity of substitution is high, it means that a small change in relative prices will cause a large change in the inputs used.