Elasticity of substitution

The elasticity of substitution indicates how to replace "light" one at a given production function and output is kept constant, a factor of production (eg labor ) by another (eg capital ).

Formal:

Where the factor of production called and the negative sign only serves the absolute value> 0 to set, because either the numerator or denominator is always negative. It should be noted that

The marginal rate of substitution equal, which is the ratio of the prices of input factors in optimum equal to:

From the latter it follows that the elasticity of substitution indicates the optimum, by what percentage the ratio between two factors of production ( eg labor and capital input ) changed when changing the relative prices of factors of production corresponding to a percent:

The relationships are analogous when considering a budget that optimizes its benefit. The elasticity of substitution then indicates by how many percent the consumption ratio in the optimum changed at a constant level of utility between two quantities of goods when changing the price ratio between the respective goods by one percent. The bigger, the better the goods are substitutable.