Elasticity of Substitution

Abstract

The concept of the elasticity of substitution, developed by Joan Robinson and John Hicks separately in the 1930s, represented an important addition to the marginal theory of the 1870s, in the tradition of Marshall, Edgeworth and Pareto. It brought together two concepts which were already well established in the literature – the ideas of elasticities (which derive from Mill) and those of substitution (which go back to Smith). The relationship defined by the concept is a mathematical one relating to utility and production functions, with considerable economic implications. It has two applications: to the theory of production, and in particular the isoquant relationship between factor inputs, and to consumer behaviour and the indifference curve. Let us look at each in turn.