Real Factor Prices and Factor-Augmenting Technical Change

How does technical change affect real factor prices? This paper gives
a comprehensive answer for the most important benchmark used in the modern
debate: technical change is factor-augmenting and materializes in a neoclassical
economy with competitive firms equipped with a constant elasticity of substitution
(CES) production function. I establish that the effect of labor-augmenting
technical change crucially hinges on whether the economy’s capital endowment
exceeds or falls short of its amount of efficient labor. This distinction determines
the sign of the effect for sufficiently small values of the elasticity of substitution.
In the former case, labor-augmenting technical progress must increase the equilibrium
wage. In the latter case the equilibrium wage is reduced. In both cases,
technical progress increases the price of capital. Overall, the analysis stresses
that not only the elasticity of substitution but also the degree of diminishing
returns, the distribution parameters of the CES, and the level of the efficient
capital intensity matter for the effect of labor-augmenting technical change on
real factor prices. Mutatis mutandis, these considerations carry over to the case
of capital-augmenting technical change.