Machlup’s essay is a single-author theoretical article and methodological clarification. Its scope is the controversy over “elasticity of substitution” in Hicks, Joan Robinson, and Douglas: a dispute about factor shares, factor demand, and the movement from industry analysis to the economy as a whole.
THE discussion of the “elasticity of substitution” is conspicuous for its unintelligibility.
The opening attack is not anti-theoretical; Machlup respects the “tool-makers” but argues that precision has produced confusion because related but distinct concepts are being given the same name. His thesis is that Robinson’s concept, and Hicks’s appendix treatment, belong to partial-equilibrium analysis of technical substitution, while Hicks’s main text concerns general-equilibrium factor shares in the National Dividend. The word is the same, but the explanatory object differs.
The first sections reconstruct Hicks’s claim through marginal-product diagrams. Machlup separates the elasticity of demand for labour from the elasticity of substitution. If added labour leaves the total wage bill unchanged, labour’s share in a larger national income falls; unit demand elasticity therefore implies substitution elasticity below one. Conversely, unit substitution elasticity requires labour income to rise with national income, so demand elasticity must exceed one. Hence Hicks and Robinson cannot be simply equated.
Anyway, Dr. Hicks’ elasticity of substitution, determining the factors’ share in the National Dividend, is not the same as Mrs. Robinson’s elasticity of substitution.
Against Douglas, Machlup argues that the elasticity of the diminishing-product or factor-demand curve is not an independent explanation. To call a curve elastic only names its property; the deeper economic reason for that property is the availability of substitutes. Substitutability helps determine factor-demand elasticity.
The higher the elasticity of substitution the higher the elasticity of demand.
The core conceptual move is “substitution within increase.” When one factor becomes more abundant, the economy does not discard the other factor. Instead, individual industries rearrange combinations: some units of the increased factor may displace others locally, while the community as a whole absorbs a larger total supply. Substitution is thus part of the mechanism by which increase is accommodated.
The failure to grasp this idea of “substitution within increase” has been responsible for much confusion.
This leads to Machlup’s central structural distinction. In partial equilibrium, technical substitution measures changes in factor proportions in a firm or industry, but actual factor demand also depends on product demand, other factor supplies, and initial proportions. In general equilibrium, the relevant counterpart is not simple demand for national output. Changed factor prices alter relative commodity prices, so consumers substitute goods embodying more of the cheaper factor for goods embodying less. Thus the distributional concept must combine producers’ technical substitution with consumers’ commodity substitution.
The elasticity of total substitution determines the change in labour's relative share in the National product.
The later sections test the concept’s limits. Machlup treats Hicks’s symmetry claim cautiously: reversibility may hold on smooth curves, but economic cases with exhausted technical substitution, kinks, heterogeneous factors, and changing industry supplies make symmetry doubtful. Time is the final qualification. Substitution is a reaction to relative prices, but reactions require adjustment; fixed and specific capital makes short-run substitution narrower than long-run substitution with more “liquid” capital.
The elasticity of substitution is obviously an increasing function of time.
The essay remains important because it turns a formal controversy into a theory of adjustment and aggregation. Machlup’s “commonsense” is the insistence that elasticities be tied to the process they measure: industry technique, consumer choice, economy-wide factor absorption, or long-run adaptation. Its main contribution is to show that factor-share theory requires an elasticity of total substitution, not merely a production-function measure of technical substitutability.
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