Economic growth and economic development 684

Introduction to Modern Economic Growth scarce factors will be relatively more expensive, the price effect tends to favor technologies complementing scarce factors (2) The market size effect is a consequence of the fact that VH /VL is increasing in H/L The market for a technology is the workers (or the other factors) that will be using and working with this technology Consequently, an increase in the supply of a factor translates into a greater market for the technology complementing that factor The market size effect encourages innovation for the more abundant factor The above discussion is incomplete, however, since prices are endogenous Combining (15.24) together with (15.18), we can eliminate relative prices and obtain the relative profitability of the technologies as: ả ả ả H σ − γ σ NH VH = (15.25) VL γ NL L Note for future reference that an increase in the relative factor supply, H/L, will increase VH /VL as long as σ > and it will reduce it if σ < This shows that the elasticity of substitution between the factors, σ, regulates whether the price effect dominates the market size effect Since σ is not a primitive, but a derived parameter, we would like to know when it is greater than It is straightforward to check that σ T ⇐⇒ ε T So the two factors will be gross substitutes when the two intermediate goods are gross substitutes in the production of the final good Next, using the two free entry conditions (15.20) and (15.21), and assuming that both of them hold as equalities, we obtain the following BGP “technology market clearing” condition: η L VL = η H VH (15.26) Combining this with (15.25), we obtain the following BGP ratio of relative technologies (15.27) NH NL ả = µ 1−γ γ 670 ¶ε µ H L ¶σ−1 ,