Hi everyone,
I am writing about skill-biased technical change, and in particular the 2001 Acemoglu (
http://economics.mit.edu/files/283) paper on the topic, in which there is a part I am very stuck on.
In the paper he suggests there is a market size effect and a price effect which direct technological change. The price effect directs technological change to areas which are relatively more expensive, and the market size effect to areas which are relatively bigger. The elasticity of substitution between two factors plays an important part, so that a low elasticity between two inputs will result in the price effect dominating, since in this situation scarce factors are relatively more expensive and innovation will intend to economise n this. With a high elasticity, the market size effect dominates, since scarce factors do not have a different relative price, so innovation will make widely used factors more efficient.
He applies this to skill biased technical change, in which he says one of the reasons the skill premium has increased so much over the past 60 years is because of the influx of skilled workers, i.e. the market size effect is dominating, so that with more skilled workers, innovation is directed at making them more efficient and they enjoy a higher wage. On page 18 under section 4.2 he states that this will happen with no reference to the degree of substituability between skilled and unskilled workers.
This is where I am stuck. I am trying to explain the theory in words like I have above, so that it would read something like this: since the elasticity of substitution between high and low skilled workers is high, following an increase in the supply of skilled workers innovation will be directed towards complementing that factor, and they will enjoy a higher wage resulting from increased efficiency. But surely skilled and unskilled workers have a low degree of substitution? In which case surely the price effect would dominate?
I would greatly appreciate any help on this. I am sure I am making a big error somewhere, since it makes sense for the market size effect to dominate here due to the empirical evidence of the increasing wage premium over the years... I also hope what I am asking makes sense. I wouldn't have written such a long question, but I feel it wouldn't have made sense without the context of the theory.
Many thanks,
Max
Locked
